It's getting easier to understand why home builder sentiment keeps rising monthly: sales and prices are now in an established uptrend.Indeed, new home sales recorded a very solid 7.6 percent increase in May, posting at a much higher-than-expected 369,000 annualized units. Now, it's true that the national median price of a new home sold in May edged down 0.6 percent to $234,500 for the month but when we look at the past 12 months, we see that new home prices are up 5.6 percent.

We see no reason why prices will backslide for long. There simply isn't enough supply to satisfy demand. The surge of buying in May lowered new-home inventory to a 4.7-month supply at the current sales rate. This is the lowest inventory level since 2005.Lack of inventory is contributing to firming prices, to be sure, but it's also impeding sales growth. While the new home sales report exceeded the consensus estimate, sales might have posted an even stronger gain if builders had more inventory for sale. Having been burned in the past with false recovery signals, builders have maintained a conservative stance on both “spec” building and community-count growth, thus limiting sales potential.

Low inventory levels could become a greater issue in the existing-home sales market as well. Many of us have already dealt with lack of inventory in certain categories of homes. In many markets, supply is being kept tight for two primary reasons: Negative equity is one and expectations is the other.Potential sellers simply don't want to (or can't) come to the table with additional money, so they don't list their homes. As for expectations, more potential sellers are anticipating rising prices; therefore, they're holding inventory off the market anticipating higher prices. Expectations, in this way, is a self-fulfilling prophesy.

Given the trends in inventory and median prices, we weren't at all surprised to read that the S&P/Case-Shiller home price index posted a strong gain in April. In fact, the index surged 0.7 percent – an unusually large gain, last exceeded in April 2010. If you'll remember, back then, the market was riding on the expiration of the federal tax credits for first-time home buyers. The market today is without a doubt much healthier than it was in 2010.

We expect the market to remain healthy into the distant future. The NAR reports that home contract signings rose for the 13 th consecutive month, with pending home sales rising 13.3% over May 2011 and nearly 6% over April 2012. According NAR economist Lawrence Yun, we should expect to see a 9 percent to 10 percent improvement in total existing home sales for 2012.

The question that looms is, can shadow inventory derail the recovery? It's a legitimate question. After all, there are four million housing units that could potentially come to market as foreclosed or short-sale property. We're not particularly worried, though. We've previously argued that we don't think shadow inventory is a game changer. Banks are processing foreclosures in an orderly and rational fashion, while at the same time they are taking on more short sales. As we like to say, markets are clearing.

Here's a another consideration on shadow inventory. We consistently write about housing starts and new home sales, but we rarely talk about lost homes; that is, homes that are lost through neglect, fire, and natural disasters. According to U.S. Census data, we lose an estimated 300,000 housing units from such events, most of these are existing home, and many, we suspect, are in the shadow inventory. So, again, we think the housing recovery is on track for good.

Courtesy of Jessica Regan.

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