House prices have been increasing sharply lately – in fact, prices for existing homes in February were up an astonishing 10% over the previous year. What’s behind the increase?

The main reason is simple – lack of inventory. Not many homes are on the market, which means buyers are bidding on a small number of houses, driving up the price.

Lack of inventory is caused by a number of factors, including:

• Few new homes have been built since 2008;
• Banks are no longer selling many foreclosed homes, due to red tape;
• Investors have bought up a lot of homes recently and are using them as rentals; and
• Many people who would ordinarily list their homes for sale aren’t doing so, because they’re underwater on their mortgage or they can’t qualify for a new mortgage.

At the same time, demand for homes has been on the increase. This is because of both continued low mortgage rates and increased rental rates, which have made it cheaper for many people to own than to rent.

Interestingly, each year the National Association of Realtors compiles a “housing affordability index.” It compares the median home price in the U.S., the median family income, and the average mortgage interest rate. It then calculates how easy it would be for the typical family to afford the typical home, assuming a 20% down payment and 25% of gross income being devoted to house payments.

In 2012, the association says, buying a house was more affordable than at any time since it started keeping records back in 1970. And when more people can afford a home, more people will be in the market for one.

Price is a function of supply and demand, and whenever there’s both reduced supply and increased demand, you can expect higher prices to result.