House prices, after falling for more than five years, are rising again. All the major sales-price indexes show that there have been modest national increases in recent months, even after adjusting for seasonal patterns.

When foreclosures and distressed sales are excluded from the data, prices are up even more. And we should expect further gains: The asking-price index, a leading indicator of sales prices, published by Trulia Inc. (where I work), climbed at an annualized rate of 3.3 percent in the second quarter of this year, adjusted for mix and seasonality, and rose in 84 of the 100 largest U.S. metropolitan areas.

Of course, if the U.S. economy falters, due to a deepening of the economic crisis in Europe or a wave of foreclosures, prices may reverse. For now, though, the increases are widespread. For the real-estate market and housing policy, this is cause for relief, but also for some concern.

One immediate effect of the price turnaround is that inventory tightens. In the past year, beginning even before prices rose, the inventory of listed homes shrank 20 percent, due to fewer foreclosures for sale and little new construction.

Smaller inventory contributes to price increases; when there are fewer homes available, sellers can ask more. In some local markets, bidding wars have returned. Now, rising prices could even accelerate the decrease in inventory in the short term, as buyers act quickly in hopes of paying as little as possible, and sellers hold off listing their homes in anticipation of further price increases. In fact, 61 percent of people do expect prices in their local market to rise in the next year, according to a recent Trulia survey.

In the longer term, if rising prices last, inventory will grow. Higher prices will encourage more owners to sell, including some who have been “underwater” on their mortgages, as well as banks holding portfolios of foreclosed homes.

Rising prices will also cue housing developers to accelerate construction. After overbuilding during the real- estate bubble, the construction industry has been very slow to recover. New-home starts are still less than half of normal levels, and construction jobs now account for a smaller share of economy-wide employment ― 4.1 percent ― than at any time since 1946. If rising prices nudge construction closer to normal, the housing market might finally contribute to, rather than hold back, the general economic recovery.

Rising prices should also take some pressure off policy makers to “fix” the housing market, and make some mortgage- modification programs more feasible. In particular, shared- appreciation loan modifications ― in which a lender or government agency reduces the amount of principal a borrower owes in exchange for a share of any future price appreciation ― become possible when there is a reasonable chance that prices will go up.

Crucially, underwater borrowers ― those owing more on their mortgages than the property is worth ― who expect prices to rise have less incentive to default on their loans and abandon their homes.

Yet along with rising prices come two serious concerns.

First, higher prices make homes harder to afford again. When prices plummeted post-bubble, concerns about affordability faded. Even now rents are gaining faster than home prices, according to the Trulia Rent Monitor, which makes owning a better bargain than renting. Still, rising prices make it harder for renters to buy. And, in markets such as coastal California and New York City, where new construction is limited by geography and regulations, high prices put homeownership out of reach for many residents.

While San Francisco is too beautiful and Manhattan too productive ever to become cheap places to live, local policy makers could make homes in expensive cities easier to afford by loosening restrictions on new construction. They could allow higher densities, as California is attempting to do near transit stations.

In Washington, they could relax the height limit. And everywhere they could simplify and clarify the rules for approving projects. More construction in cities would mean less of it pushed out to sprawling exurban areas, where overbuilding during the bubble led to some of the nation’s most widespread foreclosures.

The second reason for concern over rising prices is that they fuel optimism. Some optimism is desirable, but unchecked optimism creates bubbles. In a recent Trulia survey, 58 percent of people said they expect prices in their local market to return to their previous peak in the next 10 years.

In Pittsburgh, Houston and other markets where prices slipped only slightly during the recession, it’s plausible that they will again reach their previous peak.

But even in the hardest-hit markets, such as Las Vegas and Sacramento, where prices rose to unsustainable levels and then fell by half or more, 56 percent of people still expect them to rise to their previous peak in the next 10 years. Such optimism can lead to a bubble if people pay more for homes that they expect to appreciate.

To ensure that rising prices and renewed optimism don’t inflate a new bubble, we must not encourage homeownership and housing construction beyond what our income and demographics can support.

Although full recovery in housing is still years off, rising prices will start reshaping the market right away ― for better and for worse. 

By Jed Kolko

Jed Kolko is the chief economist at Trulia Inc., the online real-estate marketplace. The opinions expressed are his own. ― Ed.

(Bloomberg)