A chart from Goldman Sachs:
It shows the decline in US household formation growth since the recession by three different measures.
Quite a few economists have explained the implications of this trend for the US economy in the last few years and we wrote about them last July, but let’s review them briefly before moving on to the good news.
The slower pace of household formation is a consequence of the job losses during the recession and the slow pace of recovery to this point. Mostly this is due to young adults moving back in with their parents (more on this below) rather than striking out on their own, in addition to some people who have who lost or sold their homes and moved in with others. Very straightforward: fewer jobs means fewer people who can afford to start households and more people who have to abandon their houses.
And in addition to less demand in the housing market, slower household growth accounts for the corresponding rise in people per household, the fall in the homeownership rate, and higher vacancy rates. It has also led to less demand for all the typical items — furniture, big appliances, electronics, cars — that often accompany the purchase of a home or moving into a new rental. Hence the big fall, for instance, in consumer durables as a share of consumption until the end of last year.
To get some sense of how much higher demand for housing would have been if household formation growth had remained at its pre-crisis pace, here’s an excerpt from the Goldman note:
Holding headship rates within each age group constant at their 2007 level, growth in the size of the population and changes in its age structure would have warranted annual household formation of 1.3 to 1.4 million per year over the last few years. The reason that actual household formation was only about half that amount per year was a decline in headship rates within age groups—and in particular, a sharp drop inthe headship rate for persons aged 18 to 34.
(The headship rate is simply the percentage of people in a given age group who head up households.)
The Goldman economists estimate that 60 per cent of the slowdown in household formation was caused by the decline in headship rates for the 18-34 demographic. Another 20 per cent is attibutable to declines in headship rates for the rest of the population, and the remaining 20 per cent is down to a combination of the population getting older and slower net immigration.
Here’s a chart that brings home the point:
The focus on young adults also matters for a few other reasons: 1) This is the age demographic with the highest percentage of first-time homebuyers, 2) House price increases have the highest correlation with the headship rate of this group, 3) It’s the category whose headship rates are most sensitive to changes in employment, 4) There are secular forces pushing down the headship rates for the older age groups.
Now then, we mentioned some good news…
Given recent improvements in the labour market, the economists estimate that the decline in headship rates for the 18-34 group has ended.
Think about all those households that would have been started in the last few years but weren’t because of the employment catastrophe. Presumably, with the exception of people who went back to school (and even that’s just a temporary measure), a lot of them would still like to start households, move out of their parents’ basements, whatever. If you wish to think in such terms, they represent something like the equivalent of pent-up demand for goods.
This is something to keep in mind when you hear about the inventory overhang. It’s true that there remains a big number of distressed properties that haven’t hit the market, and clearing that excess supply is influencing home prices. But it’s also true that both existing and shadow inventory are coming down pretty fast (see also here). And the point here is to remember that there’s a lot of demand for new housing that’s waiting not for prices to fall further or for inventory to clear, but simply for more jobs to be created.
And here’s something else we’ve been thinking about lately. (We’re not original on this by any means, but we can’t remember where we first stumbled across the idea.) A lot of inventory might never get sold, and to the extent that this part of shadow inventory is essentially dead property, then don’t supply-demand dynamics mean this should bolster the rebound in housing rather than hinder it?
Because maybe nobody wants to buy one of the empty houses in Las Vegas or Tampa or wherever, at any price. Many people who want to start new households will no longer want to buy houses at all. And if they want to rent, well, multifamily construction was weak even before the recession, so the new demand will lead to more investment and construction; indeed higher rents have been pushing multi-family starts up in the past year as single-family starts only started ticking up recently. So what? No reason this can’t continue.
Anyways, what we’re trying to communicate here, again, is the possibility that because the weakness in construction during the downturn overshot the boom that preceded it — if we built too much then, we’re underbuilt now — the correction in the housing market will be extremely sharp when it does happen. This is what we brought up in our post last July, but we seem to be getting a lot closer to its happening now that the labour market is recovering. (Also, we’d be remiss not to mention that the first commentator to outline how this might play out, way before anybody else, was Karl Smith — see here and here.)
When might it happen? We don’t know, but the final assessment by the Goldman economists strikes us as too cautious:
We forecast household formation of 0.8 million in 2012 and 1.1 million in 2013. Over the next five years we expect that household formation will average about 1.1 million per year. Rising headship rates for the youngest age cohort account for about 200,000 newhouseholds per year in the outer year forecasts. The remainder of the growth in new households results from underlying population growth, partly offset by falling headship rates for older age cohorts. If we were to use the Census Bureau’s baseline immigration assumptions, this would mean an additional 100,000 households per year on top of our estimates.
This gradual rebound in household formation should help absorb excess inventory in the housing market, which we currently estimate to be about 2.5 million units. Assuming net additions to the housing stock continue at the current pace of about 300,000 per year, our forecast for household formation would imply that the current excess could be cleared in about 3.5 years.
Given the long period of weak household formation, why not a stronger recovery? First, while there does seem to be evidence of pent-up demand in the 18 to 34 age group, our models suggest that headship rates are driven mainly by employment-to-population ratios. Therefore, with job growth still moderate, headship rates are unlikely to snap back quickly. Second, secular trends in some cases may continue to put downward pressure on headship rates. Falling marriage rates among the young, for example, may bechanging social norms about when adulthood begins, and delaying the formation of new households.
Goldman has used very conservative estimates in arriving at this conclusion. They assume jobs growth of 150,000 per month for the next two years, and also that net immigration will slow. But the jobs growth assumption in particular is smaller than the pace we’ve had over the last half-year. And we think there’s also the possibility of a virtuous cycle that becomes self-sustaining — more jobs leads to more housing demand which leads to more other-stuff demand which leads to more jobs, etc.
Anyways, maybe this really will take take a while to play out, maybe even a year or two, but this blogger is becoming increasingly hopeful about the possibility.