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Will real estate stay hot in 2003?
Sales were gangbusters in 2002, should be strong in 2003. But a big budget deficit could do it in.
March 20, 2003: 3:42 PM EST
By Sarah Max, CNN/Money Staff Writer

New York (CNN/Money) - The results are in. Last year was another record-setting year for real estate thanks to an economy that was weak enough to keep interest rates low, but not so weak it scared home buyers away.

Existing single-family home sales rose 5 percent in 2002, according to the National Association of Realtors (NAR) while the national median home price climbed 7.1 percent to end the year at $164,000.

Economists predict the housing market, while unlikely to break another annual record, will continue to be robust in 2003.

"I think we're going to see much of the same thing for the first half of 2003 with an improving economy later in the year offsetting slightly higher mortgage rates," said NAR chief economist David Lereah.

Of course, this assumes the unemployment rate, now around 6 percent, doesn't flirt with double-digit levels and interest rates don't increase drastically.

"If interest rates rise all bets are off," said Lereah.

Why real estate continues to thrive

"In the last two years housing has been the beneficiary of a weak economy," said Lereah, explaining that interest rates, which are at their lowest levels in 40 years, have made home ownership more affordable than ever.

It's a slightly different dynamic than we've seen in recessions past, where high interest rates drove a stake through the housing market. "This recession was brought on by the bubble bursting in the stock market, not high rates," said Lereah.

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While interest rates are by and large the most important factor behind real estate's recent success, favorable demographic trends have also helped boost housing demand.

"There is a strong push among immigrants to purchase homes," said Celia Chen, senior economist for "About a decade ago, this country had a surge in immigrants who have only recently begun the home buying process."

Adds Lereah: "While baby boomers have been trading up for more expensive homes, their children are now 18- to 26-years old and entering the market" on their own. This younger generation is actually larger than its parents' generation.

At the same time, lenders are also more willing than ever to lend money to low-income buyers, extending credit to households that weren't previously eligible to purchase homes.

"You take all of these factors together and you've got a very healthy housing market," said Lereah.

What's in the cards for 2003

Although the outlook for real estate this year is favorable, economists says they will be keeping a close eye on anything that could undermine low interest rates and stable unemployment levels.

"The potential conflict in Iraq is a bit of a wildcard," said Chen, who is basing her economic assumptions on "short and clean" conflict occurring in Iraq the first half of the year. In this case, she says, military action will not have a significant impact on the economy. "But if it takes us longer to get out of Iraq there could be negative effects on the economy."

As far as interest rates go, "I don't expect the (Federal Reserve Board) to come in and increase [short-term] rates any time soon," said Lereah, who is anticipating slightly higher rates later in the year. Long-term mortgage rates are not directly affected by Fed rate changes, though they do have a trickle-down effect on lenders.

Of course, a large and growing budget deficit may drive interest rates up anyway.

In February, the White House budget office will release its latest tally on the national budget deficit which they've indicated will be in the $200 to $300 billion range. The highest deficit in the history of the United States is $290 billion in 1992.

"I worry about a budget deficit more than anything else," said Lereah. "If the Bush administration continues to cut taxes and build up military, it will result in a higher budget deficit, which will lead to higher interest rates."

When the government has a high budget deficit, it needs to borrow money at a greater rate, which it does by issuing bonds. "What you see is the government competing with corporations in the bond market, which means something has to give," said Lereah, explaining what is known as the "crowding out effect."

When the bond market becomes "crowded," investors demand higher rates and ultimately make it more expensive for Joe and Susie Homebuyer to borrow money.

"If this does happen, I expect it would be at least another year before we see a serious increase in rates," said Lereah.  Top of page

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