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"It's a big vote of confidence for Liverpool and Merseyside. Liverpool would not have won if it were not for the fact that it is really going places," said prime minister Tony Blair when the Capital of Culture result was announced on 4 June. Max Steinberg, the Housing Corporation's director of investment in the North, adds: "Liverpool now has a major opportunity to tackle some of its long-standing problems, such as low demand. The city is beginning to show major signs of revitilisation and rebirth."

All the same, Liverpool has a long journey ahead – and housing is in the driving seat.

The city's population peaked at 850,000 in the 1930s but industrial decline has since pushed that down to only 439,000, leaving row upon row of pre-1919 terraced housing deserted and eerily silent. Whole districts are dominated by boarded-up windows and burned-out cars and have become bywords for crime and unrest; Liverpool has long been in the shadow of its neighbour, Manchester.

The Merseyside market renewal pathfinder, recently christened New Heartlands, has the daunting task of pulling 123,000 properties out of low demand. Some 76,000 of these are in Liverpool's inner core, with 25,000 in Wirral and 22,500 in South Sefton. In September, New Heartlands will bid for a share of the £500m to be shared between the nine pathfinders. In the meantime, it has been awarded £4m of early-stage funding, as announced by housing minister Lord Rooker when he visited the city earlier this month. The money will pay for a massive programme of clearance, rebuilding and regeneration.

John Glester, a regeneration expert and the recently appointed chair of the pathfinder, emphasises that the renewal is a long-term task. He says: "We're looking at a period of 10-15 years and I think the government recognises that. But it's not just about housing – we've got to take a holistic approach. We need to generate a sustainable economy, providing decent housing and all the things that go with that so people have a reason to stay. The issue in many of these areas has always been that when people do get jobs, they move out. We are looking to change that culture, and it takes time."

The pathfinder aims to shift the rate of owner-occupancy in Liverpool from 52% to 60%. It is looking into schemes to encourage and aid homeownership and plans to replace derelict terraces with places that people want to buy. Homes will range from starter flats to five-bedroom executive houses.

Work has already started. The Stanley Road corridor, which links Liverpool with neighbouring Sefton, is characterised by deserted homes and boarded-up shops. Some £750,000 of the £4m early-stage funding – which will allow the pathfinder to start work before the submission of its full bid this autumn – is being spent on the acquisition and demolition of derelict properties, as well as a feasibility study for businesses that aims to turn the road into a thriving shopping centre for locals.

New Heartlands is just one of the agencies working to bring about the city's rebirth. Another scheme, the New Deal for Communities in Kensington – arguably the city's most deprived area – has attracted £60m of government funding for a 10-year programme that began in 1999. £30m is earmarked for housing, with the rest going on landscaping, health, education and safety.

Despite the teething troubles suffered by New Deal for Communities projects across the country (HT 13 June, page 20), Kensington is beginning to feel the benefits. With the private sector being encouraged to move in and the Housing Corporation promising to keep the area high on the list of funding priorities, it can expect to see total investment of some £200m by 2009.

Kensington Regeneration is the body managing the project on behalf of the government, working closely with registered social landlord Community 7, a subsidiary of Riverside Housing Association. Eventually, Community 7 will be the only social landlord in the area. Riverside has already transferred its 1200 units in Kensington to Community 7. Local landlord LHT Group transferred 196 last year and the other 10 housing associations in the area, with a total stock of about 600, are set to follow suit. Tenants of the 296 council properties will vote on a transfer this autumn.

Community 7 chief executive Tom Maguire says: "There were 12 social landlords in the area, as well as the council. Nobody knew who to go to. The New Deal said: 'Give us one social landlord to receive stock from the city council and the RSLs.' So we formed Community 7. We are both the partner and the child of the New Deal."

As it consolidates its hold on the area, Community 7 is increasingly able to take on the role of neighbourhood manager. It will demolish and rebuild swathes of housing, working with private developers to encourage owner-occupiers to move into the district and change its demographic. It is working closely with private landlords, encouraging the more responsible among them to register with the council and get involved in housing strategy.

In line with the draft housing bill, the less savoury private landlords are finding themselves targeted by environmental health hit squads. Community 7 has also asked the National Asylum Support Service to stop working with landlords who dump asylum seekers in derelict properties.

Maguire says: "Kensington has fabulous prospects and a real capacity for change. There are some fantastic people living here – real old gents and ladies that have been here all their lives. But they have to deal with drugs and prostitutes in their areas. These people are surviving under a siege and we've got an opportunity to change that. It's really exciting – it keeps me awake at night."

Infectious enthusiasm for the city is common to those bringing about its regeneration. Gerard Murden, director of Include Neighbourhood Regeneration – a partnership between the council and CDS Housing in Dingle Granby Toxteth – is immensely proud of what his team has achieved in the past two-and-a-half years. Successes include a choice-based lettings scheme that has reduced the number of voids in the area by 70%, the establishment of 20 neighbourhood safety projects, 13 CCTV cameras and the takeover of 54 abandoned sites. He says: "This was an area that was going to go downhill very swiftly. Prices had got down to £15,000 for some houses. Today, you're looking at £62,500. The city council was very brave – it put £2.5m of its money directly in our bank account and left us to get on with it. We've got no interest in buying stock for ourselves. We buy it to demolish it and make this a place where people want to live again." The sites can then be redeveloped as public space or housing.

Murden is not afraid to be heavy-handed where necessary. One private landlord who houses asylum seekers in a house in the middle of a derelict terrace has been refusing to sell to Include, holding out for a higher price. So Murden has arranged alternative accommodation for the asylum seekers and intends to start demolishing properties on either side of the private house to squeeze him out. "He'll sell," says Murden confidently, "and we'll get the terrace down."

Include is a one-stop shop. Housing and regeneration officers work alongside education, environmental health, social services, police, the fire service and an antisocial behaviour unit. Impressed by its achievements, the council decided last month to roll out similar operations across the city's other seven districts.

Of course, not everything in Liverpool is an unqualified success. The city council has come a long way since the 1980s, when its militant left-wing stance led to its characterisation as the "basket case of local government" – but things still go wrong. Last year, housing portfolio holder Richard Kemp resigned when a regeneration plan for the notorious Norris Green estate went awry (HT 19 December 2002, page 10). A council report declared that the plan to knock down 1500 defective homes and replace them with 1700 as a mix of tenures was "not appropriate, deliverable or affordable" and the business plan "not fit for purpose". The saga has meant months of delay.

But even here things are looking up. Negotiations with developer Bishop Loch are back on track and the announcement of a new plan is expected this month. In the meantime, council officers are working to improve life on the estate. There are six neighbourhood wardens and police are working with residents to improve community safety. They have carried out an appraisal of troublespots on the estate and installed extra lighting in some areas. They recently hosted a community safety day offering residents security advice. It's not the same as new homes, but it shows the residents they have not been forgotten.

Back at the city council, housing portfolio holder Flo Clucas wants to reflect the accolade by encouraging community arts projects. She says: "There is a council team working on how we can link the Capital of Culture with housing. We want to involve arts organisations, education and museums in communities, and will support them in working with young people.

"We can give people an alternative to antisocial behaviour, even if it's something as simple as TV screens showing football games in local leisure centres. Older people can work with museums to create living histories of their lives in the city – there are opportunities for everyone to get involved.

"We really can make a difference because the people themselves have a commitment. In this city, the people want to change the look, they want to ensure that the Capital of Culture is a success. The people are the greatest asset this city has and if they want to do it I have every confidence they will."

With just five years to go until the international spotlight turns its full glare on Liverpool, the city knows it has to work fast. The council estimates that the title will directly create 1380 jobs and £53m of revenue in the cultural sector as well as increasing investor confidence, bringing in big-name businesses and thousands of tourists. When it became the Capital of Culture in 1990, Glasgow experienced a resurgence that took it to a par with its trendier big sister, Edinburgh. So, Manchester, take note: there's a new kid on your block now.