The Big Idea
A continuing surge in household formation
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 sector has taken the Fed’s rate hikes this year on the chin. Affordability has deteriorated sharply, crushing home sales and construction activity in the short term. Beneath the surface, however, the underlying demand for housing remains robust, setting the stage for a resumption of solid growth once mortgage rates recede and home prices find their fair value.
Household formation
The Census Bureau publishes a quarterly report on housing that includes estimates of homeownership rates and rental and homeownership vacancy rates. The report for the fourth quarter came out on Tuesday. This report also includes estimates of the nation’s housing inventory. Economists use the tally of occupied housing units as a proxy for household formation. For the purposes of housing supply, each occupied unit represents a household.
The evolution of household formation is one of the most important fundamentals for housing in the long run. Ultimately, demographics represent the most powerful driver of household formation, incorporating both overall population growth as well as the age distribution—important because some age cohorts are more likely to buy or rent a unit than others. There are other variables that play into the number of occupied units as well. For example, the phenomenon of young adult children living with their parents well into their 20s instead of moving into their own apartment or house depressed the rate of household formation persistently in the 2010s.
Latest data
The fourth quarter reading for household formation and occupied units jumped by over a million from the previous figure. This pushed the yearly growth for 2022 to a robust pace (Exhibit 1).
Exhibit 1: Household formation compared to housing starts
Source: Census Bureau.
As a reminder, housing starts over time should exceed household formation by 250,000 to 300,000 a year to account for declines in the housing stock—homes that are destroyed by fire or natural disaster or torn down. A significant overhang in housing inventory developed in the wake of the Global Financial Crisis, as starts were sharply higher than household formation for several years. Homebuilders reined in supply over a number of years during the 2010s, and the general consensus in the industry was that housing supply was relatively tight just before the pandemic began.
The lockdowns and switch to widespread remote work led to a massive one-off upward shift in the demand for housing. People that had been doubling and tripling up decided to get their own spaces, and some households invested in second homes to escape crowded cities. Household formation, which had averaged about 1.1 million a year in the 2010s, surged to roughly 3 million in 2020. In a short period, homebuilders found themselves years behind in meeting supply at a time when building was somewhat restricted by various lockdown rules.
My presumption at the time was that a good deal of the run-up in household formation recorded in 2020 would reverse in 2021 and 2022 as Covid faded. Indeed, in 2021, household formation totaled only 851,000, the lowest annual reading in almost a decade. Nonetheless, the 2020-2021 cumulative total still exceeded the pre-Covid trend by over 1.5 million, suggesting that more payback would come in 2022.
The readings in the first half of the year supported that view. However, household formation surged in the second half of 2022, especially in the fourth quarter. As a result, the increase for the year was about 1.6 million, faster than the underlying demographic trend. This is an especially surprising result since it occurred at a time when housing demand was being depressed by high mortgage rates and sub-par economic growth.
Undoubtedly, these estimates are subject to large quarterly swings and should not be taken as precise. Nonetheless, the fact that household formation accelerated by so much in 2022 is a very encouraging sign for the longer-run housing outlook. Despite temporarily depressed demand, the growth in household formation likely means that the housing sector will be supply-constrained again once cyclical dampers recede.
Stephen Stanley
stephen.stanley@santander.us
1 (203) 428-2556
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