Real estate: It’s time to buy again
Posted by Shawn Tully, senior editor-at-large
March 28, 2011 5:00 am

Forget stocks. Don’t bet on gold. After four years of plunging home prices, the most attractive asset class in America is housing.

A home under construction in Austin. The number of new homes in the pipeline nationwide is quite low.
From his wide-rimmed cowboy hat to his roper boots, Mike Castleman fits moviedom’s image of the lanky Texas rancher. On a recent March evening, Castleman is feeding cattle biscuits to his two pet longhorn steers, Big Buddy and Little Buddy, on his 460-acre Bar Ten Creek Ranch in Dripping Springs, a hamlet outside Austin in the Texas Hill Country. The spread is a medley of meandering streams, craggy cliffs, and centuries-old oaks. But even in this pastoral setting, his mind keeps returning to a subject he knows as well as any expert around: the housing market. “I’m a dirt-road economist who sees what’s happening on the ground, and in 35 years I’ve never seen a shortage of new construction like the one I’m seeing today,” declares Castleman, 70, now offering a biscuit to his miniature donkey Thumper. “The talking heads who are down on real estate will hate to hear this, but America needs to build a lot more houses. And in most markets the price of new homes is fixin’ to rise, not fall.”

Castleman is in a unique position to know. As the founder and CEO of a company called Metrostudy, he’s spent more than three decades tracking real-time data on the country’s inventory of new homes. Each quarter he dispatches 500 inspectors to literally drive through 45,000 subdivisions from Baltimore to Sacramento. The inspectors examine 5 million finished lots, one at a time, and record whether they contain a house that’s under construction, one that’s finished and for sale, or a home that’s sold. Metrostudy covers 19 states, or around 65% of the U.S. housing market, including all the ones hardest hit by the crash: Florida, California, Arizona, and Nevada. The company’s client list includes virtually every major homebuilder and bank — from Pulte (PHM) and KB Home (KBH) to Bank of America (BAC) and Wells Fargo (WFC).

The key figures that Metrostudy collects, and that those clients prize, are the number of homes that are vacant and for sale in each city, and the number of months it takes to sell all of them. Together those figures measure inventory — the key metric in determining whether a market has a surplus or a shortage of new housing.

Today Castleman is witnessing an extraordinary reversal of the new-home glut that helped sink prices just a few years ago. In the 41 cities Metrostudy covers, a total of 78,000 houses are now either vacant and for sale, or under construction. That’s less than one-fourth of the 343,000 units in those two categories at the peak of the frenzy in mid-2006, and well below the level of a decade ago. “If we had anything like normal levels of buying, those houses would sell in 2½ months,” says Castleman. “We’d see an incredible shortage. And that’s where we’re heading.”

If all the noise you’re hearing about housing has you totally confused, join the crowd. One day you’ll read that owning a home has never been more affordable. The next day you’ll see news that housing starts have plunged to nearly their lowest level in half a century, as headlines announced in March. After four years of falling prices and surging foreclosures, it’s hard to know what to think. Even Robert Shiller and Karl Case can’t agree. The two economists, who together created the widely followed S&P/Case-Shiller Home Price indices, are right now offering sharply contrasting views of housing’s future. Shiller recently warned that the chances were high for a further double-digit drop in U.S. home prices. But in an interview with Fortune, Case took a far brighter view: “The lack of new home building is a huge help that a lot of people are ignoring,” says Case. “People think I’m crazy to be optimistic, but housing is looking like the little engine that could.”

To see where real estate is truly headed, it’s critical to keep your eye firmly on the fundamentals that, over time, always determine the course of prices and construction. During the last decade’s historic run-up in prices, Fortune repeatedly warned that things were moving too fast. In a cover story titled “Is the Housing Boom Over?,” this writer’s analysis found that the basic forces that govern the market — the cost of owning vs. renting and the level of new construction — were in bubble territory. Eventually reality set in, and prices plummeted. Our current view focuses on those same fundamentals — only now they’re pointing in the opposite direction.

So let’s state it simply and forcibly: Housing is back.

Two basic factors are laying the foundation for dramatic recovery in residential real estate. The first is the historic drop in new construction that so amazes Castleman. The second is a steep decline in prices, on the order of 30% nationwide since 2006, and as much as 55% in the hardest-hit markets. The story of this downturn has been an astonishing flight from the traditional American approach of buying new houses to an embrace of renting. But the new affordability will gradually lure Americans back to buying homes. And the return of the homeowner will start raising prices in many markets this year.

Drumming up sales
Of course, home prices are low and home construction is weak for a reason: incredibly low demand. For our scenario to play out, America will need a decent economy, with job creation and consumer confidence continuing to claw their way back to normal.

One big fear is that today’s tight credit standards will chill the market. But we’re really returning to the standards that prevailed before the craze, and those requirements didn’t stop prices and homebuilding from rising in a good economy. “The credit standards are now at about historical levels, excluding the bubble period,” says Mark Zandi, chief economist for Moody’s Analytics. “We saw prices rising with fundamentals in those periods, and it will happen again.”

To see why, let’s examine the remarkable shift in home affordability. A new study by Deutsche Bank measures affordability in two ways: first, the share of income Americans are paying to own a home. And second, the cost of owning vs. renting. On the first metric, the analysis finds that homeowners now pay just 9.8% of their income in after-tax mortgage, tax, and insurance payments. That’s down from 17.2% at the bubble’s peak in 2007, and by far the lowest number in the Deutsche Bank database, going back to 1999. The second measure, the cost of owning compared with renting, should also inspire potential buyers. In 28 out of 54 major markets, it’s now cheaper to pay a mortgage and other major costs than to rent the same house. What’s most compelling is that in all of the distressed markets, owning now wins by a wide margin — a stunning reversal from four years ago. It now costs 34% less than renting in Atlanta. In Miami the average rent is now $1,031 a month, vs. the $856 it costs to carry a ranch house or stucco cottage as an owner. (For more, see The top 10 cities for home buyers)

Not all markets will bounce back equally, of course. Housing resembles the weather: The exact conditions are different in every city. But in general the big U.S. markets fall into two different climate zones right now. We’ll call them the “nondistressed markets” and the “foreclosure markets.” A more detailed look shows why the forecast for both is favorable.

Nondistressed markets: Ready for launch

No cities went untouched by the collapse in prices over the past few years. But markets such as Northern Virginia, Indianapolis, Minneapolis, San Diego, the San Francisco suburbs, and virtually all of Texas held up reasonably well. In those areas prices spiked far less than in bubble cities — the foreclosure markets we’ll get to shortly — chiefly because they didn’t get nearly as many speculators who thought they could flip the homes or rent them to snowbirds.

The nondistressed markets will be able to get prices rising and construction growing far faster than the harder-hit areas for a simple reason: Although some of these markets are still suffering from foreclosures, they don’t need to work through the big overhang haunting a Las Vegas or a Phoenix. The number of new homes for sale or in the pipeline is extraordinarily low in nondistressed markets. San Diego is typical. It has just 921 freestanding homes for sale or under construction, compared with 4,425 in late 2005. The challenge for these cities is to generate enough demand to reduce inventories of existing, or resale, homes. In the entire country the resale supply stands at 3.5 million houses and condos. That’s a fairly high number, since it would take more than eight months to sell those properties; seven months or below is the threshold for a strong market.

But in the nondistressed cities, the existing home inventory is lower, closer to seven months on average. So a modest increase in demand will translate into strong gains in both prices and new construction. That should happen quickly, because most of those markets — including Silicon Valley, Northern Virginia, and Texas — are now showing good job growth.

Zandi of Moody’s Analytics expects that prices will rise three to four points faster than inflation for the next few years in virtually all of the nondistressed markets. His view is that prices will increase in line with rents, which are now growing briskly because apartments are in short supply. Those higher rents will encourage buyers to cross the street from an apartment to a home of their own.

In Northern Virginia, Chris Bratz, an engineer, and his wife, Amy DiElsi, a publicist, are planning to leave their rental apartment and become homeowners for the first time. The main reason? Buying has simply become a far better deal than renting. “The market got completely inflated, then it crashed, so prices are coming back to where they should be,” says Chris. As the couple have watched prices fall, they have also watched the rent on their apartment spiral upward, reaching $2,700 a month. They calculate that they should be able to purchase a townhouse for between $400,000 and $500,000 and pay less per month for a mortgage.

The nondistressed markets will also lead the way in construction. Zandi predicts that for the nation as a whole, single-family housing “starts” — measured when a builder pours a foundation for a new home — will rise from 470,000 in 2010 to as much as 700,000 this year. A large portion of that activity will happen in nondistressed markets where a tightening supply of resale houses will start making new homes look like a good deal. “Our main competition is from resales,” says Jeff Mezger, CEO of KB Home. “The prices of those homes have stayed so low, because of low demand, that it’s hampered the ability of builders to sell new houses.”

But many would-be buyers simply prefer a brand-new house. Eventually they’ll move from renters to buyers, and the trend will accelerate now that prices are no longer dropping. In Minneapolis, Yuan Qu and her husband, Xiang Chen, a researcher at the University of Minnesota, just moved from a two-bedroom rental to a new light-blue four-bedroom ranch with a chocolate-colored roof on a spacious corner lot. They paid $400,000, a bargain price compared with a few years ago. The couple, both in their early thirties, moved to Minnesota from China six years ago. “We wanted to buy a house, and we’ve been waiting and waiting and waiting,” says Qu. “The prices went down for so long, we finally thought they couldn’t keep falling.” For Qu the only choice was new construction. “We’re not very handy people,” she admits.

Foreclosure markets: The outlook is brightening

A home off the market in Mesa, Ariz.
The true disaster areas for housing since the bubble burst have been Sunbelt cities such as Las Vegas, Phoenix, and Miami — places that boasted great job and population growth in the mid-2000s, only to suffer a housing crash that swamped them with empty homes and condos and crushed their economies. But people always want to live in those sunny locales, and their job markets are starting to recover, albeit slowly. In foreclosure markets the inventory problem is far greater because it includes not just traditional resale homes but millions of distressed properties. Fortunately those houses are now such a screaming deal that investors, including lots of mom-and-pop buyers, are purchasing them at a rapid pace. To be sure, some foreclosure markets won’t rebound for years because they’re both vastly overbuilt and far from big job centers; a prime example is California’s Inland Empire, a real estate disaster zone 80 miles east of Los Angeles.

But the outlook is brightening for Phoenix, Las Vegas, Miami, and parts of Northern California. A big positive is the tiny supply of new homes entering the market. Phoenix, for example, has a total of just 8,100 new homes that are either for sale or under construction, down from 53,000 in mid-2006. The big test in these cities is absorbing the steady stream of distressed properties. The foreclosures put downward pressure on the market far out of proportion to their numbers because of markdown pricing. “We had levels of inventory even higher than this in 1990 and 1991,” says MIT economist William Wheaton. “But they were traditional listings, not foreclosures, so they didn’t create the big discounts you get with foreclosures.”

Wheaton reckons that we’ll see a flow of around 1 million foreclosures a year, at a fairly even pace, from now through 2013. That figure is frequently cited as evidence that the market is doomed for years in most foreclosure markets. Not so. The reason is that the vast bulk of those units, probably over 600,000, according to Gleb Nechayev, an economist with real estate firm CB Richard Ellis (CBG), are being converted to rentals either by investors or their current owners. Those properties are finding plenty of renters, since the rental market is still extremely strong across the country. Remember, the millions who lost their homes to foreclosure still need somewhere to live.

A typical investor is Alex Barbalat, a Russian immigrant who’s purchased seven homes east of San Francisco in the towns of Bay Point, Antioch, and Pittsburg. His average purchase price is around $100,000 for homes that once sold for between $300,000 and $500,000. But he has no trouble finding renters, since his tenants can commute to jobs in San Francisco on the BART transit system. Barbalat is pocketing rental yields on the prices he paid of around 12%, and he’s in no hurry to sell. “I’m holding them until prices drastically rise,” he says.

Investment funds are also entering the game. Dotan Y. Melech looks for bargains in Las Vegas for UnitedAMS, a firm he co-founded that manages apartments and other real estate investments. The firm has raised more than $20 million from outside investors to purchase distressed properties. So far, Melech has bought around 300 houses and plans to purchase another 200 this year. He has no trouble renting the houses he buys, since, he estimates, occupancy rates in Las Vegas are touching 95%. The “cap rate,” or return on investment after all expenses, is between 8% and 10% — twice the rate on 10-year Treasuries. Melech rents to people who lost their homes but are reliable renters. “A lot of people can’t be buyers because their credit got hurt,” he says.

Even with investors jumping in, buying activity in foreclosure markets hasn’t yet increased enough to bring inventories down. It will soon. Zandi thinks prices will fall a couple of percentage points lower in the distressed markets in the short run. “But that will be overshooting,” he says. “It’s like an elastic band. If prices do drop this year, they will need to bounce back because they’ll be far too low compared with rents and replacement cost.” Renters will come off the sidelines to purchase homes in the years ahead, precisely the opposite trend of the past few years.

Consider the example of Michael Dynda, a retired Air Force avionics technician who now works for a government contractor in Las Vegas. Dynda, 49, is a first-time buyer who put off purchasing for years, in part because prices were falling so rapidly in Las Vegas, with no bottom in sight. But last year the combination of bargain prices and low mortgage rates became too good to resist. He ended up purchasing a 2,300-square-foot stucco home for $240,000, or about half what it would have fetched in 2007. Dynda got a 4.38% home loan, and pays the same amount on his mortgage as on the rent on the house he left to become a homeowner. “The timing was about as good as it could get,” says Dynda.

Mike Castleman’s company tracks the inventory of new homes in 19 states across the country. He sees supply getting tight. “Home prices are fixin’ to rise,” he says.
Back on the ranch, Mike Castleman is lounging in his creek-front mansion, built from “a hundred tons of fine central Texas limestone.” As he shows off his collection of custom-made guitars, including one crafted to resemble the skin of a rattlesnake, the homespun housing guru once again returns to his favorite topic.

Castleman claims that this recovery will look like all the others: It will bring a severe shortage of housing. He invokes the livestock business to explain. “It takes three years between the time a bull mates with a cow and when you get a calf ready for market,” he says. “That’s how it is in housing too. We’ll get a big surge in demand and the drywall companies will take a long time to ramp up, and it will take years to get new lots approved. Buyers will show up looking for a house in a subdivision, and all the houses will be sold. The builders will tell them it will take six months to deliver a house.” But those folks, says Castleman, will be set on buying a place. “And they’ll want it so bad they’ll bid the prices up!” In other words: Beat the crowd.

It’s a Great Time to Buy a House
Mike Castleman, the Texan with the best realtime view of housing in the U.S., tells editor-atlarge Shawn Tully that the naysayers are about to get a big surprise: rising prices for new homes.

The typical rate that lenders are offering on a standard 30-year mortgage is back below 4% for the second time this year, Freddie Mac says.

The rate fell from an even 4% in Freddie’s survey last week to 3.99% in the survey released Thursday. The 3.94% recorded in the Oct. 6 report was the lowest in the 40 years that Freddie Mac has been asking lenders across the country about the rate they are offering on the 30-year loan.

The typical interest rate on the 15-year fixed home loan dropped from 3.31% to 3.30% in the latest survey. Borrowers would have paid less than 1% of the loan balance in fees to obtain the loans, Freddie Mac said.

Solid borrowers who shop around often find slightly better rates than those in the survey, and paying additional points upfront to lenders also can lower the rate.

The mortgage rates are a huge boon for home buyers and refinancers with solid credit and income, 20% down payments or 20% home equity — the kind that would qualify for the loans of up to $417,000 that the survey focuses on.

But they are available at a cloudy time. Foreclosures are rising again, and the rates are scraping bottom mainly because investors are so spooked by the European debt crisis. That has increased demand for U.S. debt securities, still presumed to be a safe haven.

That demand has depressed the yield on Treasury securities, and mortgage rates tend to track Treasury yields. And there is too little in the recent mixed economic news to suggest that inflation could reassert itself in the United States, driving interest rates higher.

“The economy added 80,000 net jobs in October, below the market consensus forecast, but employment gains over the prior two months were revised up by 102,000 and the unemployment rate fell to 9.0 percent, the lowest in six months,” Freddie Mac economist Frank Nothaft said. “Factory orders improved in September, yet the expansion in the service industry slowed in October.”

Jed Smith is managing director of quantitative research for the National Association of Realtors. He says that short sales and bank-owned homes will account for around 35% of U.S. housing deals for the next three years. We asked him how he sees the outlook for housing …

Us: What will the industry’s mood be in November when Realtors gather for NAR’s annual convention in Anaheim?

Jed: Realistic optimism in terms of sales and price expectations may be the important issues. Most sources appear to view the market at or near its bottom with modest recovery in a number of regions. People recognize that the economic and job recoveries are slow, but there is a general belief that we have already seen the worst of the bad news.

There is also recognition, however, that we really can’t predict anything — given that governmental, international, and consumer trends and actions have become increasingly unpredictable with the prolonged Great Recession. Unknown unknowns, frequently mentioned as Black Swans, are increasingly an important factor. Therefore, to the degree that we can foresee and predict, I think the outlook will be one of cautious optimism.

Us: The housing recovery is on anything but warp speed. How much longer will this downturn go on?

Jed: Sales have fluctuated, ranging on an overall yearly basis between 4.9 million and 5.2 million since 2008. As of May, home sales were in the 4.8 million range annualized, and we expect approximately 5.1 million existing home sales for 2011 and 5.3 million in 2012 as the economy continues to recover and create additional jobs.

Jobs are the key driver of sales, and the disappointing job market over the last few years appears to have impacted the existing home sales market. We now appear to be in a recovery mode.

It looks like home sales will be stronger in the second half of the year, but healthy job creation is necessary to ensure a solid recovery in both housing and the overall economy. The job market has sputtered recently, and because variations in local job creation impact housing demand, the housing markets will recover unevenly around the country.

Prices have been a major disappointment in recent years. Part of the price weakness in existing home sales has been to the overall deleveraging in the economy, and part of the price situation has been driven by the significant number of distressed home sales (foreclosures and short sales) that have driven the markets. Approximately 35% of existing home sales are distressed, and while the number will fluctuate from month to month, we expect to continue to have a distressed property situation for the next three years.

We expect price stabilization in the forthcoming years, with modest increases in areas where jobs are created and distressed inventories decrease. Absorption of inventory is the key to price improvement, and we expect this to occur in forthcoming months.

Us: What’s holding the housing market back?

Jed: As a result of the Great Recession we have issues of job creation and loan availability. We think that there is a significant level of pent-up demand given the overall growth in the number of households in the past 10 years, but pent-up demand can only be realized if there is a meaningful gain in jobs.

In addition, low interest rates are not particularly beneficial if financial institutions have unrealistically high credit standards due to excessive risk aversion. Finally, some additional recovery of consumer confidence, which will probably occur as people realize that the Great Recession is over, will help to facilitate the housing markets. We are already seeing modest improvements on a local basis in home sales and prices, and hopefully the recovery will gather steam.

Us: Can the market get back on its feet with so many underwater and defaulting homes out there?

Jed: The existing home sales market is absorbing distressed properties as they come onto the market. Unfortunately, distressed properties tend to sell at discounts of 20% to current market prices. The total level of foreclosures and short sales has been in the neighborhood of 35% of overall existing home sales for the past several years, sometimes more, sometimes less on a monthly basis.
The outlook for the immediate future is for moderately rising sales and increasing price stability, with modestly rising prices in areas with good job recovery and loan availability. We would like to be able to forecast a booming recovery; however, the realistic outlook is for modest improvements on a continuing basis.

Us: Most say the market is hampered by tight lending standards. Has the pendulum has swung too far?

Jed: Interest rates continue to be near historic lows, but credit availability is limited. Many consumers are simply unable to obtain loans — even with substantial down payments in hand and credit scores in the 800 range. We get approximately 1,000 comments every month in response to our Realtors Confidence Index survey, and our members cite numerous examples of responsible potential buyers being unable to get mortgages. Financial institutions appear to have become unduly risk averse. This has a major negative impact on the housing markets.

The pendulum has indeed swung too far. Dr. Bernanke has recently noted that credit availability is an issue — and he should know, being chairman of the Federal Reserve Board. Our view is that if banks would simply return to normal sound underwriting standards and begin lending to more creditworthy borrowers, we’d get a much faster recovery in the housing sector.

Us: Any final thoughts?

Jed: There is a tendency to focus on prices and housing as an investment when discussing the existing home sales markets. However, people buy houses because of lifestyle preferences — the desire to own a home for personal and family reasons.

In addition, NAR surveys indicate that homeowners currently own a home, on average, for approximately 8 years; monthly or even yearly fluctuations in value are actually of no significance to most homeowners.

Although there are clearly financial benefits to owning a home, the clear benefit of homeownership is the actual enjoyment of the home as a place to establish roots, build a future, and live your life — not the maximization of a financial portfolio strategy.

Posted in: Insider Q&A • Jed Smith • National Association of Realtors • trends

Us: Chapman’s forecast of 6% home-price drops in 2005 were greeted by catcalls from the real estate industry. Prices actually increased 16.5% that year. But 2007 proved that you were right, only that your timing was off. Prices ultimately dropped 43%. Was a housing market correction inevitable? And why were industry professionals so reluctant to accept the economics behind your forecast?

Esmael: Our home price forecasting model is driven by several economic and financial variables. The key variables are job growth, income, mortgage rates, new and resale housing supply, and housing affordability index. These variables were suggesting that home prices should drop rather than increase in 2004 and 2005. The use of creative financing, a large number of real estate investors and second homebuyers masked the fundamental economic factors leading to double-digit home price appreciation. In addition, an important factor was consumers’ psychology which is very difficult to quantify and that along with industry professionals’ psychology was another main driver. And bubbles are more often based on psychology rather than economic reasons. That is why trying to time turning points in the housing price cycle is so difficult and fraught with error. In the end, however, economic factors rule.

Us: Of course, you’ve been telling audiences that the 43% drop in median home prices and the subsequent 22% comeback are “bogus numbers.” Why are they bogus and how much did people’s home values really adjust in this past slump?

Esmael: Yes, I believe the median home prices reported by the California Association of Realtors and the Dataquick do not represent what is happening to the prices of existing stock of housing. These measures are based on the median price of homes that were sold in a particular month and are significantly affected by the mix of homes sold. When the bubble burst, it first affected the subprime mortgages which were concentrated in cheaper homes. As a result, most of the foreclosed properties or short-sales were relatively cheaper homes and the median price dropped significantly. As transactions moved from relatively cheaper homes to a more expensive homes, the median was pulled up. So the price of my house or yours neither declined by 43% nor it subsequently increased by 22% as reported.

Us: Back in April 2008 — after home prices had already fallen by a hefty amount — Chapman predicted that home prices were going to drop 14% more because the average house payment still was well above the historical average of 32.6% of household income. Prices actually fell another 26%. Did house payments ever get down to the 32.6% historical average? Where are they now and what does your affordability gauge say about future prices?

Esmael: Affordability along with other economic variables pointed to a 14% decline in existing home prices. But again, the changes in the mix of homes sold exaggerated the price decline. It is also important to remember that the most important element in forecasting is to capture the direction of the changes rather than the exact number (Getting the exact number right would be pure luck!)

Mainly because of the decline in home prices and low mortgage rates, housing affordability has improved significantly. A homebuyer with the median family income of about $78,000 needs to allocate 28.4% of that income for principal and interest payments (after tax savings) if he decides to buy a median-priced home.

Us: What’s your latest outlook for housing in Orange County? Are we in a housing double dip recession or has the recovery finally taken root?

Esmael: Looking at the fundamentals, there are a few positive developments. First, job creation is picking up steam. Second, personal income is increasing. And finally, mortgage rates although are expected to increase are still at historical low. These factors are particularly helpful to a first-time homebuyer that has a stable job and reasonably clean credit history. That should help to induce demand for median or below median-priced homes leading to stable and higher prices in this segment of the market.

There are, however, a few negative factors in the market place. There are still many homeowners that are underwater and need to refinance their mortgages and some of those homes will end up as a short-sale or foreclosed property. This along with existing shadow inventory in the market place will lead to stubbornly high inventory particularly for relatively more expensive homes leading to a downward price pressure in the more expensive segment of the market.

Overall, we should not see a significant downward or upward changes in median home prices this year. At best, the median prices will remain flat.

Us: Last question … for people sitting on the sidelines, is now a good time to buy, and how long should buyers plan to stay in their home to ride out any future price drops?

Esmael: Yes, this is an excellent time for the first-time homebuyers to enter the market if they have a relatively long time horizon to live in the property (five years or more) and more importantly they love the house that they’re buying. As I mentioned above, the high-end of the market may experience more price declines and a potential buyer can wait and could be able to buy what they like at a cheaper price down the road.

It is highly important to remember that buying a principal residence is a consumption and not an investment. So people should buy the house that they love to live in and have a long-term plan for staying in the house.

Posted in: Insider Q&A • Chapman University • Esmael

Forget stocks. Don’t bet on gold. After four years of plunging home prices, the most attractive asset class in America is housing.

From his wide-rimmed cowboy hat to his roper boots, Mike Castleman fits moviedom’s image of the lanky Texas rancher. On a recent March evening, Castleman is feeding cattle biscuits to his two pet longhorn steers, Big Buddy and Little Buddy, on his 460-acre Bar Ten Creek Ranch in Dripping Springs, a hamlet outside Austin in the Texas Hill Country. The spread is a medley of meandering streams, craggy cliffs, and centuries-old oaks. But even in this pastoral setting, his mind keeps returning to a subject he knows as well as any expert around: the housing market. “I’m a dirt-road economist who sees what’s happening on the ground, and in 35 years I’ve never seen a shortage of new construction like the one I’m seeing today,” declares Castleman, 70, now offering a biscuit to his miniature donkey Thumper. “The talking heads who are down on real estate will hate to hear this, but America needs to build a lot more houses. And in most markets the price of new homes is fixin’ to rise, not fall.”

Castleman is in a unique position to know. As the founder and CEO of a company called Metrostudy, he’s spent more than three decades tracking real-time data on the country’s inventory of new homes. Each quarter he dispatches 500 inspectors to literally drive through 45,000 subdivisions from Baltimore to Sacramento. The inspectors examine 5 million finished lots, one at a time, and record whether they contain a house that’s under construction, one that’s finished and for sale, or a home that’s sold. Metrostudy covers 19 states, or around 65% of the U.S. housing market, including all the ones hardest hit by the crash: Florida, California, Arizona, and Nevada. The company’s client list includes virtually every major homebuilder and bank — from Pulte (PHM) and KB Home (KBH) to Bank of America (BAC) and Wells Fargo (WFC).

The key figures that Metrostudy collects, and that those clients prize, are the number of homes that are vacant and for sale in each city, and the number of months it takes to sell all of them. Together those figures measure inventory — the key metric in determining whether a market has a surplus or a shortage of new housing.

Today Castleman is witnessing an extraordinary reversal of the new-home glut that helped sink prices just a few years ago. In the 41 cities Metrostudy covers, a total of 78,000 houses are now either vacant and for sale, or under construction. That’s less than one-fourth of the 343,000 units in those two categories at the peak of the frenzy in mid-2006, and well below the level of a decade ago. “If we had anything like normal levels of buying, those houses would sell in 2½ months,” says Castleman. “We’d see an incredible shortage. And that’s where we’re heading.”

If all the noise you’re hearing about housing has you totally confused, join the crowd. One day you’ll read that owning a home has never been more affordable. The next day you’ll see news that housing starts have plunged to nearly their lowest level in half a century, as headlines announced in March. After four years of falling prices and surging foreclosures, it’s hard to know what to think. Even Robert Shiller and Karl Case can’t agree. The two economists, who together created the widely followed S&P/Case-Shiller Home Price indices, are right now offering sharply contrasting views of housing’s future. Shiller recently warned that the chances were high for a further double-digit drop in U.S. home prices. But in an interview with Fortune, Case took a far brighter view: “The lack of new home building is a huge help that a lot of people are ignoring,” says Case. “People think I’m crazy to be optimistic, but housing is looking like the little engine that could.”

To see where real estate is truly headed, it’s critical to keep your eye firmly on the fundamentals that, over time, always determine the course of prices and construction. During the last decade’s historic run-up in prices, Fortune repeatedly warned that things were moving too fast. In a cover story titled “Is the Housing Boom Over?,” this writer’s analysis found that the basic forces that govern the market — the cost of owning vs. renting and the level of new construction — were in bubble territory. Eventually reality set in, and prices plummeted. Our current view focuses on those same fundamentals — only now they’re pointing in the opposite direction.

So let’s state it simply and forcibly: Housing is back.

Two basic factors are laying the foundation for dramatic recovery in residential real estate. The first is the historic drop in new construction that so amazes Castleman. The second is a steep decline in prices, on the order of 30% nationwide since 2006, and as much as 55% in the hardest-hit markets. The story of this downturn has been an astonishing flight from the traditional American approach of buying new houses to an embrace of renting. But the new affordability will gradually lure Americans back to buying homes. And the return of the homeowner will start raising prices in many markets this year.

Of course, home prices are low and home construction is weak for a reason: incredibly low demand. For our scenario to play out, America will need a decent economy, with job creation and consumer confidence continuing to claw their way back to normal.

One big fear is that today’s tight credit standards will chill the market. But we’re really returning to the standards that prevailed before the craze, and those requirements didn’t stop prices and homebuilding from rising in a good economy. “The credit standards are now at about historical levels, excluding the bubble period,” says Mark Zandi, chief economist for Moody’s Analytics. “We saw prices rising with fundamentals in those periods, and it will happen again.”

To see why, let’s examine the remarkable shift in home affordability. A new study by Deutsche Bank measures affordability in two ways: first, the share of income Americans are paying to own a home. And second, the cost of owning vs. renting. On the first metric, the analysis finds that homeowners now pay just 9.8% of their income in after-tax mortgage, tax, and insurance payments. That’s down from 17.2% at the bubble’s peak in 2007, and by far the lowest number in the Deutsche Bank database, going back to 1999. The second measure, the cost of owning compared with renting, should also inspire potential buyers. In 28 out of 54 major markets, it’s now cheaper to pay a mortgage and other major costs than to rent the same house. What’s most compelling is that in all of the distressed markets, owning now wins by a wide margin — a stunning reversal from four years ago. It now costs 34% less than renting in Atlanta. In Miami the average rent is now $1,031 a month, vs. the $856 it costs to carry a ranch house or stucco cottage as an owner. (For more, see The top 10 cities for home buyers)

Not all markets will bounce back equally, of course. Housing resembles the weather: The exact conditions are different in every city. But in general the big U.S. markets fall into two different climate zones right now. We’ll call them the “nondistressed markets” and the “foreclosure markets.” A more detailed look shows why the forecast for both is favorable.

Nondistressed markets: Ready for launch

No cities went untouched by the collapse in prices over the past few years. But markets such as Northern Virginia, Indianapolis, Minneapolis, San Diego, the San Francisco suburbs, and virtually all of Texas held up reasonably well. In those areas prices spiked far less than in bubble cities — the foreclosure markets we’ll get to shortly — chiefly because they didn’t get nearly as many speculators who thought they could flip the homes or rent them to snowbirds.

The nondistressed markets will be able to get prices rising and construction growing far faster than the harder-hit areas for a simple reason: Although some of these markets are still suffering from foreclosures, they don’t need to work through the big overhang haunting a Las Vegas or a Phoenix. The number of new homes for sale or in the pipeline is extraordinarily low in nondistressed markets. San Diego is typical. It has just 921 freestanding homes for sale or under construction, compared with 4,425 in late 2005. The challenge for these cities is to generate enough demand to reduce inventories of existing, or resale, homes. In the entire country the resale supply stands at 3.5 million houses and condos. That’s a fairly high number, since it would take more than eight months to sell those properties; seven months or below is the threshold for a strong market.

But in the nondistressed cities, the existing home inventory is lower, closer to seven months on average. So a modest increase in demand will translate into strong gains in both prices and new construction. That should happen quickly, because most of those markets — including Silicon Valley, Northern Virginia, and Texas — are now showing good job growth.

Zandi of Moody’s Analytics expects that prices will rise three to four points faster than inflation for the next few years in virtually all of the nondistressed markets. His view is that prices will increase in line with rents, which are now growing briskly because apartments are in short supply. Those higher rents will encourage buyers to cross the street from an apartment to a home of their own.

In Northern Virginia, Chris Bratz, an engineer, and his wife, Amy DiElsi, a publicist, are planning to leave their rental apartment and become homeowners for the first time. The main reason? Buying has simply become a far better deal than renting. “The market got completely inflated, then it crashed, so prices are coming back to where they should be,” says Chris. As the couple have watched prices fall, they have also watched the rent on their apartment spiral upward, reaching $2,700 a month. They calculate that they should be able to purchase a townhouse for between $400,000 and $500,000 and pay less per month for a mortgage.

The nondistressed markets will also lead the way in construction. Zandi predicts that for the nation as a whole, single-family housing “starts” — measured when a builder pours a foundation for a new home — will rise from 470,000 in 2010 to as much as 700,000 this year. A large portion of that activity will happen in nondistressed markets where a tightening supply of resale houses will start making new homes look like a good deal. “Our main competition is from resales,” says Jeff Mezger, CEO of KB Home. “The prices of those homes have stayed so low, because of low demand, that it’s hampered the ability of builders to sell new houses.”

But many would-be buyers simply prefer a brand-new house. Eventually they’ll move from renters to buyers, and the trend will accelerate now that prices are no longer dropping. In Minneapolis, Yuan Qu and her husband, Xiang Chen, a researcher at the University of Minnesota, just moved from a two-bedroom rental to a new light-blue four-bedroom ranch with a chocolate-colored roof on a spacious corner lot. They paid $400,000, a bargain price compared with a few years ago. The couple, both in their early thirties, moved to Minnesota from China six years ago. “We wanted to buy a house, and we’ve been waiting and waiting and waiting,” says Qu. “The prices went down for so long, we finally thought they couldn’t keep falling.” For Qu the only choice was new construction. “We’re not very handy people,” she admits.

Foreclosure markets: The outlook is brightening

The true disaster areas for housing since the bubble burst have been Sunbelt cities such as Las Vegas, Phoenix, and Miami — places that boasted great job and population growth in the mid-2000s, only to suffer a housing crash that swamped them with empty homes and condos and crushed their economies. But people always want to live in those sunny locales, and their job markets are starting to recover, albeit slowly. In foreclosure markets the inventory problem is far greater because it includes not just traditional resale homes but millions of distressed properties. Fortunately those houses are now such a screaming deal that investors, including lots of mom-and-pop buyers, are purchasing them at a rapid pace. To be sure, some foreclosure markets won’t rebound for years because they’re both vastly overbuilt and far from big job centers; a prime example is California’s Inland Empire, a real estate disaster zone 80 miles east of Los Angeles.

But the outlook is brightening for Phoenix, Las Vegas, Miami, and parts of Northern California. A big positive is the tiny supply of new homes entering the market. Phoenix, for example, has a total of just 8,100 new homes that are either for sale or under construction, down from 53,000 in mid-2006. The big test in these cities is absorbing the steady stream of distressed properties. The foreclosures put downward pressure on the market far out of proportion to their numbers because of markdown pricing. “We had levels of inventory even higher than this in 1990 and 1991,” says MIT economist William Wheaton. “But they were traditional listings, not foreclosures, so they didn’t create the big discounts you get with foreclosures.”

Wheaton reckons that we’ll see a flow of around 1 million foreclosures a year, at a fairly even pace, from now through 2013. That figure is frequently cited as evidence that the market is doomed for years in most foreclosure markets. Not so. The reason is that the vast bulk of those units, probably over 600,000, according to Gleb Nechayev, an economist with real estate firm CB Richard Ellis (CBG), are being converted to rentals either by investors or their current owners. Those properties are finding plenty of renters, since the rental market is still extremely strong across the country. Remember, the millions who lost their homes to foreclosure still need somewhere to live.

A typical investor is Alex Barbalat, a Russian immigrant who’s purchased seven homes east of San Francisco in the towns of Bay Point, Antioch, and Pittsburg. His average purchase price is around $100,000 for homes that once sold for between $300,000 and $500,000. But he has no trouble finding renters, since his tenants can commute to jobs in San Francisco on the BART transit system. Barbalat is pocketing rental yields on the prices he paid of around 12%, and he’s in no hurry to sell. “I’m holding them until prices drastically rise,” he says.

Investment funds are also entering the game. Dotan Y. Melech looks for bargains in Las Vegas for UnitedAMS, a firm he co-founded that manages apartments and other real estate investments. The firm has raised more than $20 million from outside investors to purchase distressed properties. So far, Melech has bought around 300 houses and plans to purchase another 200 this year. He has no trouble renting the houses he buys, since, he estimates, occupancy rates in Las Vegas are touching 95%. The “cap rate,” or return on investment after all expenses, is between 8% and 10% — twice the rate on 10-year Treasuries. Melech rents to people who lost their homes but are reliable renters. “A lot of people can’t be buyers because their credit got hurt,” he says.

Even with investors jumping in, buying activity in foreclosure markets hasn’t yet increased enough to bring inventories down. It will soon. Zandi thinks prices will fall a couple of percentage points lower in the distressed markets in the short run. “But that will be overshooting,” he says. “It’s like an elastic band. If prices do drop this year, they will need to bounce back because they’ll be far too low compared with rents and replacement cost.” Renters will come off the sidelines to purchase homes in the years ahead, precisely the opposite trend of the past few years.

Consider the example of Michael Dynda, a retired Air Force avionics technician who now works for a government contractor in Las Vegas. Dynda, 49, is a first-time buyer who put off purchasing for years, in part because prices were falling so rapidly in Las Vegas, with no bottom in sight. But last year the combination of bargain prices and low mortgage rates became too good to resist. He ended up purchasing a 2,300-square-foot stucco home for $240,000, or about half what it would have fetched in 2007. Dynda got a 4.38% home loan, and pays the same amount on his mortgage as on the rent on the house he left to become a homeowner. “The timing was about as good as it could get,” says Dynda.

Mike Castleman’s company tracks the inventory of new homes in 19 states across the country. He sees supply getting tight. “Home prices are fixin’ to rise,” he says.
Back on the ranch, Mike Castleman is lounging in his creek-front mansion, built from “a hundred tons of fine central Texas limestone.” As he shows off his collection of custom-made guitars, including one crafted to resemble the skin of a rattlesnake, the homespun housing guru once again returns to his favorite topic.

Castleman claims that this recovery will look like all the others: It will bring a severe shortage of housing. He invokes the livestock business to explain. “It takes three years between the time a bull mates with a cow and when you get a calf ready for market,” he says. “That’s how it is in housing too. We’ll get a big surge in demand and the drywall companies will take a long time to ramp up, and it will take years to get new lots approved. Buyers will show up looking for a house in a subdivision, and all the houses will be sold. The builders will tell them it will take six months to deliver a house.” But those folks, says Castleman, will be set on buying a place. “And they’ll want it so bad they’ll bid the prices up!” In other words: Beat the crowd.

It’s a Great Time to Buy a House
Mike Castleman, the Texan with the best realtime view of housing in the U.S., tells editor-atlarge Shawn Tully that the naysayers are about to get a big surprise: rising prices for new homes.

The latest Orange County home inventory report from local broker Steve Thomas — data as of March 17 — says …

“Demand is at its highest level since August of last year. That’s correct. Demand is taking off DESPITE the lack of government intervention in the form of a tax credit. Last year at this time the market was very robust. But, right after the first time home buyer tax credit ended at the end of April, demand took a giant nosedive. … The real estate market is finally following a normal cyclical pattern, something it has not done in years. … Demand, the number of new pending sales over the past month, increased by 225 in just two weeks and now totals 2,982. At the beginning of the year, demand was at 1,856 pending sales. Since then, it has increased by 61%. Last year at this time there were 288 additional pending sales, propped up by the $8,000 first time homebuyer tax credit.”

Thomas calculates a “market time” benchmark tracking how many months it theoretically takes to sell all the inventory in the local MLS for-sale listings at the current pace of pending deals being made. By this Thomas logic, as of last Thursday, it would take:

3.63 months for buyers to gobble up all homes for sale at the current pace vs. 3.90 months two weeks ago vs. 2.68 months a year ago vs. 4.35 months two years ago.
Of the 8 pricing slices Thomas tracks, 7 had faster market time vs. 2 weeks ago; and 3 improved over a year ago.
Homes listed for under a million bucks have a market time of 3.29 months vs. 8.24 months for homes listed for more than $1 million.
So, basically, it is 2.5 times harder to sell a million-dollar-plus residence!
And just so you know, the million-dollar market represents 16% of all homes listed and 7% of all homes that entered into escrow in the past 30 days.

The Irvine Co. is “doubling down” on its fledgling, but wildly successful homebuilding program, opening up the first phase of the long-delayed Stonegate development in north Irvine.

Ultimately, up to 2,000 new housing units will sprout up in the now-empty fields northeast of the Woodbury development between Jeffrey Road and Sand Canyon Avenue in north Irvine — many of them built by firms buying lots from the Irvine Co.

But the first phase will consist of 650 homes, all built by the Irvine Co.’s revived homebuilding brand, Irvine Pacific Homes.

As part of the “Irvine Pacific Collection,” the new project is the successor to the company’s “2010 New Home Collection” that so far has resulted in 1,234 homes sold. The 2010 initiative consisted of 12 projects in the Irvine Co. developments of Woodbury, Woodbury East and Stonegate East.

Said Dan Young, Irvine Co. homebuilding chief and president of Irvine Pacific:

“There is a legitimate, deep demand for new homes in our area. Therefore, we made a very substantial financial commitment by doubling down.”

Stonegate will have a mix of townhomes and houses, ranging from 1,100 to 3,000 square feet, with prices ranging from the mid-$300,000s to the high $700,000. The sales office will open on April 9.

A 6,700-square-foot design center will open in March in nearby Woodbury, and respresentatives of Wells Fargo and Bank of America will be embedded in the sales office to smooth over the lending process.

Product types within Stonegate include:

Santa Clara: Townhomes from 1,129 to 1,322 square feet, with prices starting in the mid-$300,000s.
San Mateo: Single-family homes from 1,636 to 1,818 square feet, with prices starting in the mid-$500,000s.
San Marcos: Single-family homes from 1,824 to 2,066 square feet, with prices starting in the low $600,000s.
Maricopa: Single-family homes from 2,262 to 2,974 square feet, with prices starting in the high $700,000s.
Young said that minor design changes have been made in the new projects based on feedback from last year’s buyers. But the big ideas of having a large open “great room,” and a covered indoor-outdoor space called a “California room” will be among last year’s innovations incorporated in the new projects.

Not long ago, you could have your big remodeling project and get your money back too. Owners recouped an average of 87% of home improvement costs at resale in 2005, according to Remodeling magazine.

But by 2010 the magazine had pegged the typical payback at just 60%. Hardly the right time to tackle the new kitchen or master bathroom you’ve been dreaming of, right?

Not so fast, says Kermit Baker, senior research fellow at Harvard University’s Joint Center for Housing Studies. (Now that job title has gotta look packed on a biz card)

“In many cases, these projects make more sense now than they did at the height of the market,” he said.

Assuming you like what you can’t change about your home — the neighborhood, the school district, the proximity to things that matter to you — and you’re planning on staying for five or more years, improving your home is a smart move. Here’s why.

1. Funding is cheap
The current economic climate sweetens the pot for people on solid financial footing.

Should I spend $60,000 to renovate my house?
“The Fed doesn’t want you to save — it wants you to put your dollars into circulation,” said Keith Gumbinger, mortgage market analyst at HSH.com.

Today’s historically low interest rates mean that most home-equity lines of credit are charging their floor rates (your HELOC’s probably is around 3% if you’ve held it for a couple of years, 4% or 5% if the loan is more recent).

And with the typical bank account and money fund paying far less than 1%, drawing down your savings barely costs you anything in lost income — just don’t jeopardize your safety cushion.

2. Eager contractors are discounting
Although the construction industry rebounded somewhat last year, business is still slow. Remember when getting a contractor to call you back was a challenge?

Now the best pros in town will happily bid on your job — and they’ll probably offer you prices that are 10% to 20% below what you would have paid when real estate was going gangbusters, according to Bernard Markstein, senior economist for the National Association of Home Builders.

3. Materials have come down
The cost of building supplies has tumbled too. Plywood is down 23% since its peak in the mid-2000s. Drywall is off 29%, framing lumber 35%.

Not all raw materials prices have fallen that much: Asphalt roofing, which is made from a petroleum byproduct, is down only 7% over the past two years. Insulation — which has been in high demand because of energy rebates and high fuel prices — is down a mere 2% since 2006. Still, on the whole, construction supplies are bargains right now.

4. You’ll cut your energy costs
You don’t have to hire a green builder to see energy savings from a renovation. In a prewar house in the high-energy-cost Northeast, for example, a standard kitchen remodel could cut your utility expenses by $400 a year thanks to new insulation, windows, and appliances.

Even years of such savings will never come close to covering the project’s price tag, but think of your lower electric and heating bills as an annual dividend.

5. Fixing up costs less than trading up
With the median home price down 22% since 2006, you might think this is an opportune time to trade up for the new master bathroom or other modern feature you want. After all, why not buy somebody else’s remodeling headache at a discount.

But you can’t assume that you’ll easily sell your house in this tough market and then find a new place that has the exact features you want (and not a bunch of stuff you don’t want). And moving remains far costlier than improving, said John Ranco, past president of the Greater Boston Association of Realtors.

For starters, commissions and fees to sell a $400,000 home could run $25,000.

“You can get a lot of remodeling done for that kind of money,” said Ranco. “And that doesn’t even include the higher price you’re paying for the new house, the moving costs, or the inevitable painting and window treatments the new place will need.”

6. You can keep that sub-5% mortgage
As long as you’re not underwater and haven’t wrecked your credit, you’ve been able to take advantage of recent rock-bottom interest rates to lock in a fixed-rate mortgage below 5%.

Move several years from now, and you’ll have to give up that loan, probably for something in the sixes or sevens, said Harvard’s Baker. That’s not bad, but it could mean hundreds a month in added interest costs.

“If you can remodel your way into staying put long term, you can hold on to that once-in-a-lifetime rate,” says Baker.

7. Smart projects still add value
In the post-boom era, the rule of thumb for gauging the potential payback from a home improvement is simple: If you’re bringing your house in line with similar homes in the area, you’ll most likely earn back the lion’s share of the cost when you sell. If you’re surpassing the neighborhood, you probably won’t.

“Remodeling a 10-year-old kitchen because you don’t like its style doesn’t pay anymore,” says Thomas Collimore, director of investor education for the CFA Institute. “But replacing a 1960s kitchen is a different story.”

At least for the foreseeable future, buyers will either lowball their bids or pass on your house entirely unless you’ve already tackled this kind of deferred renovation.

8. You get to enjoy the results
When it comes time to sell your place, chances are you’ll probably wind up having to do the sorely needed renovations you didn’t take care of earlier. Not only does that add a huge amount of stress to the process of putting a house on the market, but you still end up spending the money (quite possibly when contractor, materials, and borrowing costs are higher).

Why not get the benefits of a new furnace or an updated powder room for you and your family instead of buying them for the house’s next owners? And why not do the projects soon so you get as much time as possible to enjoy the results?

Unlike vacations, luxury cars, or other discretionary expenditures, your remodeling project might recoup a significant chunk of its cost someday.

Even so, home improvements aren’t purely investment decisions — you shouldn’t redo a kitchen or bathroom in the hopes of making a profit. But if you want to upgrade the quality of your home life and you can afford the cost, it’s money well spent

California Realtors confirmed a report out earlier this week showing local house prices fell in December to their lowest level in 20 months.

The price at the midpoint of all Orange County house sales, or the median price, fell last month to $458,700, the California Association of Realtors reported today.

That’s the lowest the median price has been for an existing single-family home here since April 2009. Last month’s pricing is equivalent to levels hit in the spring of 2003 — wiping out 7 1/2 years of home-price appreciation.

On Tuesday, MDA DataQuick reported a median house price of $470,000 for Orange County, down 5.7% and likewise the lowest since April 2009.

CAR’s latest housing report shows also:

Last month’s median house price was down 8.7% from November’s median and 7.5% from December 2009.
Sales of local single-family homes fell 5.6% from a year ago — the smallest sales drop since the number of housing transactions turned negative five months ago.
O.C. had six months worth of homes on the market in December — meaning that it would take six months to sell all the listings at December’s sales pace. That’s the second-lowest “unsold inventory” figure for the county this year, though it’s up from 5.4 months in December 2009.
Statewide, the median house price fell 1.6% over the past year to $301,850.
California house sales, however, rose in December to their highest level since May. If sales continued at December’s pace for an entire year, 520,680 would change hands.
CAR Chief Economist Leslie Appleton-Young said:

“While sales rose in December, the sales pace in the second half of the year was lower than the first half as the housing market weaned itself off home buyer tax credits. For 2010 as a whole, sales reached 494,900 homes sold, down 9.5% from the 546,860 homes sold in 2009. However, the statewide median price increased 10.2% to reach $302,900 for the year, up from the $275,000 recorded in 2009.”

Newport Beach will be getting a pair of penthouse homes with waterfront views — in an old bank headquarters building viewed as an historic architectural gem.

The 1960s-era, 60-foot-tall office building at 3388 Via Lido — the old Newport Balboa Savings offices — is getting a complete overhaul. The plan is highlighted by the creation of “two luxury, two-story penthouse homes each with more than 5,000 square feet of living space” that will be constructed above two floors of offices, according to a press release from the developers Marshall Property & Development and Bayfront Holdings.

The future
Matt Montgomery of Marshall: “We are completely repositioning the building to include new exterior glazing and all new building systems; the vision is to create the most unique waterfront property in California that can be a catalyst for the future of Lido Village. The penthouses will be particularly spectacular, with floor-to-ceiling windows that open to views of Catalina Island and Newport Harbor. The homes will also include outdoor living spaces and expansive balconies.”

Nearby, Marshall and partners plan to turn 3355 Via Lido — old retail and office space — into a 17 townhouse projects as part of an overall rethinking of Newport’s Lido Village. The two properties were sold as a pair last year, reportedly for $13.6 million after originally being listed for $15.5 million.

The office tower at 3388 Via Lida was designed by Peruvian-born W.A. Sarmiento. His work, according to a tribute website, “led to the construction of hundreds of cutting-edge mid-century modern buildings nationwide. Many towns had never imagined setting their sights on what Sarmiento planted in their downtowns before then! He became a driving force behind revolutionizing the look and feel of banking in postwar America between 1952 and 1964.”
This office structure was added in 1961 behind Newport Balboa’s distinctive bayside branch, which thanks to its waterfront location apparently had “yacht-in” service. Says the Sarmiento website: “The office building addition added a new compliment of multi-colored sun-shading louvers and a playful folded plate roof as a cap. The waving folded plate element signified the location of the rooftop restaurant that was a popular destination for many years with its outstanding view of the Newport Bay.”