In the backdrop of a slow growing economy, Fitch Ratings projects the housing recovery will expand this year and the next-just not at an “explosive” pace, according to a report.

The forecast for 2013 is for existing-home sales to increase 7.5 percent and for new home sales to rise by 22 percent. Meanwhile, single-family starts should grow 18 percent, and multifamily starts should jump 25 percent.

In 2014, the improvements should continue but at a slower rate, with multifamily starts forecast to rise 9 percent and single-family starts to increase 24 percent. Existing sales will slow to 5 percent growth, and new home sales will stay on course with a 24 percent increase.

According to Fitch, the market faces housing challenges such as negative equity, strict mortgage qualification standards, lot shortages, materials and labor costs pressuring home prices, and excess supply in certain markets due to foreclosures.

In the midst of the challenges, however, Fitch pointed to factors supporting the market, such as “still-attractive” home prices and low mortgage rates.

While the recent surge in rates is not expected to stop the recovery, Fitch warned that if rates were to make another leap from current levels or if credit terms became more constrained, then Fitch’s forecast for this year would become more pessimistic.

When addressing inventory constraints on a national level, Fitch also cautioned that that this could change.

“[A] fragile economy slipping into recession could inflame issues, such as negative buyer psychology and home price erosion relatively quickly, which can lead to a falloff in demand and bloated inventories,” the report stated.

Interestingly, Fitch speculates banks could be in control of a “sizeable amount of housing inventory” based on data from the National Association of Realtors, which showed only 15 to 20 percent of foreclosures during the downturn hit the market in 2008 and 2009. This leaves the remaining 80 to 85 percent of foreclosures as bank-owned properties.

According to the report, banks currently offer “top dollar” at auctions to keep their distressed properties, “frequently paying above assessed value.” The rating agency stated banks would rather hold distressed properties rather than sell them and suffer losses, and they’re expecting the properties to appreciate in the next couple of years.

By Esther Cho