I came across an interesting research paper from the Federal Reserve related to household formations. Here’s the title, author, date, and link:
The Long and the Short of Household Formation
April 1, 2013
The supply of housing is fairly easy to quantify from statistics published related to building permits and housing starts. Pinning down demand is more difficult and is influenced by demographic factors (e.g. aging households are smaller so there’s typically more of them), social trends (e.g. more divorces lead to more households being formed), and economic factors (e.g. the more jobs being created, the more ability people have to afford to form new households). Apartment owners have benefited from a relatively low supply of apartments up until recently because of the capital/lending constraints resulting from the tightening of credit due to the near meltdown of the banking system in 2008 and 2009. Although supply is starting to increase materially, we still don’t believe there’s enough housing being created to satiate the demand and this will continue to benefit apartment owners despite the improving single-family market. One of the under-appreciated sources of demand is the large number of people who moved back home with their parents during the recession. This is now starting to reverse as job growth has been fairly steady over the last few years and younger people are getting hired. Given the still relatively tight mortgage market and underwriting standards, this cohort is far more apt to rent once they move out again. The point of all of this is that economic factors play a critical role in household formations. Household formations were exceptionally low during the Great Recession and now it would appear there’s a lot of pent up demand with the economy on more firm footing and the population continuing to grow. The paper referenced above confirms this assertion. The author believes that economic factors have trumped the demographic and social ones and that household formations are poised to grow fairly significantly over the next four years if his model is accurate, which of course is always subject to potential modeling errors, the future being different than the past, etc. Nevertheless, I thought it was worth referring to and here is the punch line from my perspective:
Given the predicted headship rate, the predicted pace of household formation depends on aggregate population growth. Between the 2000 and 2010 Censuses, the adult U.S. population grew by about 25 million, or 2.5 million per year. The Census Bureau projects that average population growth from 2012 through 2020 will be somewhat slower, about 2.2 million per year. Even if the headship rate were to remain at at its 2012 level of about 51.5 percent, we would thus expect new household formation of 1.1 to 1.2 million per year, substantially higher than in recent years. If the headship rate follows the model projection from figure 6, household formation will be faster, averaging 1.5 to 1.6 million per year from 2013 until 2017, at which point it will slow as the headship rate reaches a level consistent with roughly full employment.
Although housing starts are definitely on the upswing, except for the recent downturn which many think is an anomaly, the following chart shows that we are still not producing enough housing to meet the estimated demand of 1.1 to 1.6 million new homes (single-family and multi-family) as suggested by the author.