Last week, The National Association of Realtors said existing home sales were up just 0.4% with inventories being reported as the reason for a lower than expected reading. In fact, inventories across the U.S. fell 4.9%, or 25% year-on-year, to 1.74 million, which was the lowest since Dec. 1999.

It seems that those lower inventories, low interest rates and hungry buyers helped push prices higher as well. Earlier this morning, the S&P/Case-Shiller 20-city composite index posted a 0.2% increase in December, following a 0.1% decline in November. After seasonal adjustment, home prices rose 0.9% in December. December’s prices were up 6.8% from the same period in 2011, with increases in 19 of 20 cities. This reading caps the best calendar year gain since the 15.5% surge in 2005.

New home sales figures just released from the Commerce Department showed that units sold leapt 15.6% in January to an annual rate of 437,000 to mark the highest month of activity since July 2008 (seasonally adjusted). Sales in January topped economists’ estimates for 384,000 in annualized sales. December sales were revised up to 378,000 from an initial read of 369,000

The West (The California & Arizona effect) saw the greatest increase over the same period last year, up 45.3%, and Northeastern states also saw a substantial increase of 27.6%. Northeastern sales may have gotten an early jolt from unseasonably warm winter weather that persisted from December into early January. New home sales on average are roughly 29% higher compared to one year ago.

The supply of new home inventory fell to 4.1 months at the current sales rate from 4.8 months in December, the lowest level since 2005.

Contrasting the S&P Case Shiller reading, the median price of new homes fell more than 9% to $226,400 in January from $249,800.

What strikes me as odd is the fact that housing starts (reported last Wednesday) fell 8.5% to an annual rate of 890,000 in January with building permits up 1.8% to 925,000. The important single-family starts rose just 0.8% to 613,000, which is slightly above the 600,000 threshold that reflects a neutral housing recovery.

The week prior, the National Association of Home Builders Housing Market Index (HMI) slipped to 46 from 47 in February, continuing below the neutral reading of 50. Uncertainty about the job market, home buyer access the mortgage credit, rising costs for building materials, limited availability of labor and desired lot locations were all reasons cited.

Here is where I get a bit confused…

If prices are so strong and inventory so low, why aren’t we seeing more homes being built? Why are quality home builders like Toll Brothers warning investors about upcoming earnings?

I have been thinking about these questions quite a bit and here is my thesis:

• Home prices have increased substantially, but when compared to the major correction in prices in such a short duration, it is more of stabilization than a strong recovery. I believe that home prices will rise at 2-3% in 2013, then 2% in 2014. Maybe getting us back to 2005 levels if we are lucky, but still off 40%+ from the highs.

• Homebuilders have picked all the low-lying fruit and now have to deal with elevated prices of materials and sale prices that are 50% less than what they could sell for at the peak. There is also a desire for less expensive homes making the task even more daunting. Land costs, code requirements and local zoning laws make it extremely hard for builders to slap up cheap housing that lacks minimum quality standards.

• Rent rates are through the roof and a temporary way out for home builders to make some cash while many Americans still struggle with the ability to buy homes. We are seeing several home builders get into the rental business and perhaps convert those tenants into buyers eventually.

• Not all home builders are created equal, Toll had a high multiple and high expectations with a focus on certain types of homes. We need to stop lumping them all together.

• Sales rates are peaking now and will taper off as current inventory is gobbled up and home builders are more selective about building and/or move into the rent market.

Do you think the price and sales trends will stay strong in housing for years to come?

Are these sales increases sustainable for the next year given the inventory situation and home builder sentiment?