The Big Idea
Housing supply still looks tight in the long run
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The US continues to have a structural shortage of housing after years where household formation typically has outpaced housing starts. The near-term outlook for housing may be downbeat with bloated inventories and demand weakened by high interest rates. But a structural housing deficit bodes well for a pickup in construction once borrowing rates moderate and affordability improves.
Household formation
The Census Bureau publishes a quarterly report on the housing market that includes estimates of homeownership rates and rental and homeownership vacancy rates. The numbers for the second quarter came out last Wednesday. The 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 estimating housing demand, each occupied unit represents a household.
The evolution of household formation is one of the most important fundamentals for the housing sector 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, with some age cohorts 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.
More recently, the presumed acceleration in immigration flows over the past couple of years would only further exacerbate the structural deficiency in housing supply.
Supply shortfall
Since the beginning of Covid, household formation has significantly exceeded housing supply. This shows up in comparisons of the Census Bureau annual household formation proxy to housing starts (Exhibit 1).
Exhibit 1: Household formation since 2010 has regularly topped housing starts
Source: Census Bureau.
As a reminder, housing starts over time should exceed household formation by about 250,000 to 300,000 a year to account for homes destroyed by fire, natural disaster, or other causes or torn down. A significant overhang in housing inventory developed in the wake of the Global Financial Crisis as starts ran sharply higher than household formation for several years. Homebuilders reined in supply for 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 from view. 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 could come in 2022 and forward.
Since then, however, household formation has settled into a relatively rapid growth trend. The number of occupied housing units increased by 1.85 million in 2022 and 1.64 million in 2023, significantly outpacing housing starts in both years. Over the past four years, household formation has exceeded housing starts by about 1.4 million cumulatively. Add in the fact that housing starts should exceed household formation over time by at least 250,000 a year, and the structural housing shortage has widened since Covid by about 2.5 million units.
Moreover, barring a steep slowdown in the second half of the year, the supply gap will likely widen further in 2024. Housing starts have run at about a 1.4 million unit annualized pace in the first half of this year, roughly on par with the year-over-year advance in household formation through the second quarter, which implies that supply may fall behind by an additional 250,000 to 300,000.
While the near-term outlook for the housing sector is dark, the nation faces a housing shortfall of millions of units, which should provide a tailwind to the sector for years, especially once mortgage rates normalize. In the meantime, however, the structural tightness of the housing market is likely to keep shelter costs firmer than they might otherwise be, making it harder at the margin for the Federal Reserve to achieve its 2% inflation target.
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