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Construction up, but are we building too many houses?

The year-end numbers are in, and home construction improved dramatically in 2013. Both single- and multi-family housing starts were up, by 15 and 25 percent, respectively, according to the U.S. Census. Add it all up and total housing construction rose 18 percent from 2012 to the highest level since 2007.

Now for a little perspective. Last year was the best year for single-family home construction since 2009, but that's not saying much since it also was fifth worst on record. Single-family starts came in at just under 618,000. Compare that to the height of the housing boom in 2005, when 1.7 million single-family homes were built. The historical average is right around a million, so we're barely half way back.

That perspective might make some say we still need to ramp up construction more, build more homes. The nation's home builders would certainly say that. Or are we building about enough? Or even too much?

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"The vacancy rate has been declining, which means we are building less than the number of new households," said Jed Kolko, chief economist at Trulia. "But the vacancy rate is still higher than it was before the bubble, which means we should be building fewer homes than the growth in households, because there still is an excess of vacant homes."

Empty houses, either owned by the banks or investors, are still a blight to many communities and are still keeping home prices from recovering fully. There is also a huge surge in rental demand. While some of that is in the single-family market, the bulk is in multifamily apartments. Developers are well aware of that.

(Read more: For the billionaire who wants it all: A fully loaded home)

Multifamily apartment construction is surging much more than single family. At just under 292,000 units started, construction volume is now nearly three times what it was in 2009 and right around the 10 year, prerecession average. What has changed, however, is the purpose of these apartments. During the housing boom, less than 60 percent of these structures were built as rentals. More than 40 percent were sold as condominiums. Today, 92 percent of multifamily starts are intended for rental, the highest since the Census began tracking this data set in 1974.

"Rents won't rise as much as you might think, given the growing rental demand, because there is all this new apartment rental supply that should come onto the market next year. Without the increase in starts, rent increases would be much steeper," said Kolko.

Rent growth is already moderating, but home price growth is still going strong, at least for the existing home market. The conundrum is that much of that growth is fueled by all-cash investors. These investors generally do not buy new construction. They tend to center on the lower end or distressed market. The home ownership rate, which excludes investor properties, is still declining, at 65.3 percent at the end of the third quarter of 2013, according to the Census. That's down from a peak of 69.2 percent in 2004. If you subtract the nearly 4.5 million borrowers who are not current on their mortgages or who are in the foreclosure process, that rate is even lower, according to Black Knight Financial Services.

(Read more: Builder sentiment falls slightly in January)

It begs the question, will new home sales meet new home construction? Will demand outweigh supply and allow builders to continue to raise prices? New home sales were running nearly 30 percent higher in November than in November 2012, but still about a third of what they were during the housing boom and well below historical norms. Both employment and income growth are still not strong, and job participation is way down. Still, some are hopeful for a turnaround.

"Builders are facing the headwind of rising construction costs, but buyer traffic has held up well despite rising mortgage rates," said Patrick Newport of IHS Global. "After hitting a plateau in the middle of 2013, the market for new homes is poised for a stronger 2014."

As home prices rise and more borrowers come back into a positive equity position on their properties, more will choose to put their homes on the market; those existing homes will compete with new construction. If there are enough buyers, home prices will hold or rise. If not, and there are too many homes for sale compared to demand, prices will weaken.

(Read more: Mortgage refinances bounce back as rates settle)

—By CNBC's Diana Olick. Follow her on Twitter @Diana_Olick.

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  • Diana Olick serves as CNBC's real estate correspondent as well as the editor of the Realty Check section on CNBC.com.

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