JAN 24, 2014 4:36pm ET

Home Price Increases Not Leading to More Building Activity

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Nevada, California, Arizona and Florida respectively saw the largest year-over-year increases in home prices at the end of the third quarter, according to the Federal Housing Finance Agency. But at the same time, these same states have seen its homebuilding activity remain low.

Through 3Q13, Nevada home values appreciated on a yearly basis by 25%, while California was up by 23%, Arizona 15% and Florida 12%.

However, there is no continuity between rising home prices and homebuilding. Relative to long-run norms, Nevada, Arizona and Florida have among the lowest rates of building permits per capita in the country. Even though California is not one of the 10 states furthest below in average building permit levels, the Golden State is still below its typical amount.

"These low levels of homebuilding include a number of large, master-planned communities already under construction in all four states, which have added significantly to the permit numbers," says Paul Diggle, property economist at Capital Economics.

One reason why California has not seen too many construction projects recently is that it is a hard state to obtain a building permit, Diggle added.

Meanwhile, the other three states that had a substantial turnaround in home prices are seeing new construction activity slow down due to the "glut of cheap, distressed homes which flooded the market during the recession and crowded out homebuilders," Diggle says.

"The upshot was that homebuilders selling relatively more expensive new homes experienced an unprecedented drop in demand," Diggle continued. "The long lags involved in putting together funding, acquiring land and navigating the planning process mean that building volumes remain subdued today."

Furthermore, all four states were the hardest hit during the housing crisis in terms of property values plummeting, high rates of negative equity and some of the largest foreclosure inventories nationwide. Since this inventory is slowly being worked through, there is a "resurgence in homebuilding" being projected for these states.

For example, housing demand there is relatively strong. When ranking all 50 states by home sales per capita relative to long-run levels, Nevada is tops, Arizona is fourth and sales are stronger than average in California and Nevada. Additionally, the backlog of distressed properties is clearing quickly, where the foreclosure inventory rate has fallen from an average of 9.2% to 4.2% within these four states.

"Homebuilders are likely to respond to strong demand and rapidly rising prices by breaking ground on more sites," Diggle says. "An increase in homebuilding in these four markets is another reason to expect national homebuilding volumes to rise strongly in 2014."

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