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The surging, sustained demand for homes

| October 30, 2020

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.

The housing market has been one of the strongest sectors of the economy during the post-lockdown recovery. The virus has sparked or accelerated trends toward expanding demand for homes, leading to an explosion in home sales and historically thin inventories of homes for sale. Builders had struggled to meet demand before the pandemic, and the latest pace of household formation shows just how daunting the task is for builders to fill the need for homes going forward.

Covid and housing demand

The advent of the pandemic in early 2020 led to a halt in the housing sector as it did for much of the economy. However, the abrupt change in how people worked and lived created a sudden boost to housing demand that became evident as soon as the lockdowns ended. Many households suddenly wanted to move. Households with multiple generations crowded into a single place sought separate accommodations for safety from the virus. The trend toward work-from-home and, for a time at least, school-from-home led people to seek more space to accommodate home offices. Finally, many urban dwellers wanted to move to the suburbs or even further out, where the population was less dense. Work from home has made such a move possible for many more households than before.

The net result has been a shift in demand from urban apartments to suburban and rural single-family homes. Many households are seeking more house. In addition, the trend toward more dispersed living arrangements has increased the number of housing units needed to fulfill overall demand.

Household formation

Economists use quarterly data from the Census Bureau on the housing stock as a proxy for household formation. In particular, the series on the number of occupied housing units offers an estimate of the number of unique households in the country for the purposes of gauging housing demand.

Household formation can rise because of population growth. For example, every time a family immigrates to the country, presumably the family needs a place to live. However, families can in theory double- or even triple-up in houses or apartments. In addition, multiple generations may choose to live under a single roof. The trend of jobless millennials living in their parents’ basements rather than getting their own apartment, for example, means a net decline in household formation relative to what might normally be the case.

The trends detailed above that resulted from the pandemic suggest a pickup in household formation. Even without a change in the overall population, if people choose to spread out more, living in less dense arrangements, there will be a one-off jump in household formation.

Census Bureau data

The Census Bureau data bear out this hypothesis. Household formation, which had sagged in the years during and following the Great Financial Crisis, had already begun to bounce back in the latter half of the last decade (Exhibit 1). The baseline annual increase in households in recent years has been close to 1.5 million.

Exhibit 1: Household formation has trended higher since 2008

Note: Annual Q4/Q4 growth in number of occupied housing units in the US.
Source: Census Bureau.

Household formation and housing starts

Over time, home builders should add to the housing stock roughly in proportion to the increase in household formation plus some increment to account for homes that are torn down or destroyed by fire, flood, tornado, hurricane or other forces. Housing starts track household formation (Exhibit 2). Comparing starts and formation shows the overbuilding that took place during the housing boom of the 2000s as well as the sluggish response of builders during the slow recovery in the 2010s. In particular, over the past several years, household formation has significantly outpaced housing starts, suggesting that builders were falling behind demand. Indeed, measures of homes on the market pointed to thin inventories and a tight housing market nationally even before the pandemic.

Exhibit 2: Household formation and housing starts

Source: Census Bureau.

This year

The developments in 2020, largely reflecting the impact of the pandemic, have significantly widened the gap between supply and demand. The second quarter reading of occupied housing stock surged by well over 2 million units, and the third quarter reading held virtually all of that gain. The annual gain so far this year, from the fourth quarter of 2019 through the third quarter of 2020, is an astonishing 4 million units.

This should offer a new context for the robust housing starts readings in recent months. After averaging 1.3 million last year and diving to around 1 million in April and May, starts have jumped to 1.4 million. That would be a solid gain in normal circumstances, but builders would need to build more than 4 million units this year just to keep up with the presumably one-off surge in demand.

As we have seen from the new home inventories data, finished new homes are getting snapped up for the most part, and an increasing proportion of new homes for sales are not yet started. Builders are falling so far behind that the housing sector order back may begin to resemble airplane manufacturers’ normal procedure, where you have to place an order years in advance to get a place in line.

There are two takeaways for the outlook for the housing sector. First, housing starts could in theory go far higher if builders could ramp up their operations. Unfortunately, builders were complaining about labor shortages before the pandemic, so it may not be so easy to expand their activity dramatically. In any case, builders will have ample demand for as many homes as they can construct for the foreseeable future. Second, it could take several years for the housing sector to equalize supply and demand. If you imagine that builders can only bump up the annual pace of housing starts by about 200,000 units, then, in theory, it would take 10 years to fulfill the 1-time shock of adding 2 million units to demand. That does, of course, assume that the 2020 pandemic jolt to demand is fully sustained. In reality, some of the boost may be an acceleration of flows that would normally have taken place over a period of years. Even so, it is hard to imagine that housing supply can catch up to demand any time soon.

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