By David F. Seiders. Home sales and single-family starts were remarkably strong during the economic recession of 2001 and the sluggish recovery of 2002. Both years also displayed strong increases in house prices and heavy borrowing against equity by America's homeowners. Without these two pillars of support, the recession would have been much deeper and the recovery might not yet be under way.

This remarkable housing performance naturally has raised questions about sustainability in 2003. It's going to be tough to match the new-home sales and starts rates of 2002, but the NAHB expects volume that's about equal to the average of 2001-2002 and close to our projected average for the entire decade. On the house price front, some deceleration probably is in the cards for 2003, but real (inflation-adjusted) gains should continue to accumulate in most places and absolute declines in prices will be quite rare.

Interest rate factor

It's fair to say that historically low interest rates were central to housing's performance in 2001-2002, with respect to both the volume of housing market activity and the strength of home prices. It's also fair to say that rates are likely to rise to some degree in 2003.

But the impact of higher interest rates on home sales and prices depends critically on the reasons for the rate increases. In 2003, upward pressure on interest rates will be associated with a strengthening economic recovery that will be generating stronger growth in employment and household income, factors that should roughly offset negative impacts on housing demand from the rate increases. Frankly, a stronger economy and modestly higher interest rates generate a better housing outlook than would continuation of a stagnant economy and somewhat lower rates.

Housing equity driver

It's true that the low interest rates of 2001-2002 generated a tremendous volume of borrowing against housing equity through cash-out refinancings and other means, but that well has by no means run dry. Indeed, Federal Reserve data show that housing equity was a good bit higher in late 2002 than a year earlier, despite the rapid growth in home mortgage debt, as a combination of very large capital gains and sizeable net purchases powered the market value of household real estate to higher and higher records. Thus, 2003 began with a record store of wealth in housing equity, although higher interest rates may hold the volume of borrowing against equity somewhat below the record pace of 2002.

Rental market issues

The strength of home sales in 2001-2002 relied to an important extent on shifts of renter households to first-time homeownership. This phenomenon, combined with steady completions of new apartment units, opened up sizeable vacancies in the stock of rental housing, prompting apartment managers to roll out rent concessions and other techniques to retain and attract tenants. These efforts, along with somewhat higher mortgage interest rates, should help stem the rent-to-own tide in 2003, without affecting the fundamental strength of the single-family market. Single-family starts should top 1.3 million units for the second year in a row.