Organisation of households: Household formation and the housing market
Phuah Eng Chye (17 March 2018)
Household formation has been the traditional force powering the housing market and economic growth. Derek Thompson observes “more formations is good news. It suggests more people getting jobs, getting apartments, getting married, having kids, and (in all likelihood) spending more money to furnish their new households and express their independence…This recovery, however, has been a story of few jobs, crowded apartments, low marriage-rates, and low birthrates. It all comes down to households.”
But in tandem with demographic aging and the shrinkage in typical household size, there has been a growing divergence between the composition of a family and a household unit[1]. The changes in household organisation are weakening household formation and dampen the housing market and economic growth. Derek Thompson notes in the US, “unemployment among Millennials is about twice the national average, and real wages for young people have declined outright since 2007. As a result, one in three older teens and twentysomethings reported moving back in with their parents. That means they weren’t starting new households. They weren’t paying rent, taking out mortgages, buying furniture, paying separate utility bills — all of which fall under the Housing Category, which accounts for nearly a fifth of GDP. “
Timothy Dunne adds “the greatest shortfall occurred among young adults and that it is related to weak economic conditions. Housing choices have shifted as well, with a greater proportion of young households living in rental housing rather than owner-occupied homes… While younger adults between the ages of 18 and 34 make up a relatively small proportion of heads of households, they account for almost three-quarters of the overall shortfall in household formation.”
Another outcome from changing household structures is to shift preferences from ownership to rental. Chava Gourarie observes rising rents, budget constraints, mutual support, safety, commuting convenience, better amenities and a culture built around sharing is motivating more millennials to co-live with roommates in crowded cities.
Timothy Dunne agrees, noting “reduced access to mortgage credit, the weak economy, and uncertainty about the path of the housing market have decreased the likelihood that young heads of household will live in owner-occupied housing today.” In this regard, “while such increases in household formation will certainly aid the housing market, it is an open question how increased formation will affect the relative demands for rental or single-family owner-occupied housing. The sharp decline in home ownership rates for the younger cohort shows little sign of recovering, suggesting that when young adults start forming more households, it may have a stronger impact on the demand for rental properties than owner-occupied housing over the near term.”
The weakness in household formation has attracted policy concern. One important issue is whether the weakness in household formation is temporary or structural. Under traditional paradigms, it is recessionary forces rather than demographics that weakens household formation. Hence, poor employment prospects, the fall-out from the bursting of the housing bubble, tighter lending standards and heavy student debt burden are the major factors causing individuals to defer forming a household.
In tandem with this, Timothy Dunne notes “the shortfall in household formation observed over the 2007–2010 period is an outgrowth of the weak economy and does not reflect fundamental changes in underlying demographics. It is not unreasonable to expect that the rate will rebound further as individuals who delayed forming households during the recession and initial recovery set out on their own.”
Barry Ritholtz thinks the recovery is in sight as “homeownership bottomed in mid-2016[2], and has gained a full percentage point since then…Millennials are forming new households, moving to the suburbs, buying furnishings and SUVs. According to Zillow Group data, people aged 18 to 34 have become the largest group of homebuyers in the U.S…The reversal of this phenomenon is an important contributor to the momentum behind the economic recovery from the credit crisis; it also is potentially significant for the next leg up in U.S. equity markets…This points to a rise in spending on furniture, appliances, electronics and cars that will lift earnings and power stocks.” He attributes the recovery to: 1) rising rents are making it more attractive to buy than to rent; 2) the strengthening economy; and 3) the end of the after-effects from the credit crisis of 2007.
However, the traditional paradigms perceive weakening household formation within the context of an economic cycle that eventually reverses direction. The logic is that “household formation is miserable now, but it’s projected to pick up for a simple reason: an improving economy is bound to encourage young people to get out, buy apartments, and get married, eventually.”[3]
But the assertion the current weak household formation is a cyclical phenomenon understates the significance of the structural forces at work that are shrinking the household size and increasing the diversity of household composition. For example, smaller family sizes reduce the motivation to move out of parents’ homes[4] – less crowded households increase the likelihood of inheriting a house and reduces the need to buy.
In addition, the increased diversity in household compositions and greater lifetime uncertainties in relation to employment (job and location transience, risks of job loss), and income changes attitudes towards marriage and home ownership. These factors, combined with higher debt levels (student and consumer loans) and high house prices, will dampen the desire for youths to buy a home with adverse consequences for long-term household formation trends. Hence, the changes in household organisation suggest the current weakness in household formation is structural rather than cyclical.
But the obvious puzzle is that the behaviour of housing markets relative to household formation has hardly been textbook-like with the simultaneous co-existence of weak household formation and skyrocketing housing prices. This is due to several developments:
- The massive expansion of central bank balance sheets and debt has generally supported asset prices and more specifically housing prices in the major global cities.
- Houses have become an important asset class. The introduction of housing mortgage securities, various property investment vehicles and sharing platforms has improved the liquidity and income-generating prospects of houses. This has enhanced the status of houses as an attractive investible asset.
- Global demand is crowding out locals in major cities. Shortages of affordable housing occur mainly in the top global cities which is attracting massive population inflows. Global institutional and high net-worth foreign buyers are willing to pay a substantial premium and this has caused house prices to skyrocket and become unaffordable for domestic buyers.
Hence, the globalisation of demand for houses as an investible asset provide a reasonable explanation to why household formation is weak but housing prices have become unaffordable. It also explains why there are so many “empty” or unoccupied units despite the housing shortages.
The interesting contrast is Japan, an aging economy where housing prices appear to remain trapped in stagnation-type circumstances. There are several potential explanations why the Japanese experience was closer to the classic textbook behaviour. First, the Japanese government implemented initiatives to expand housing supply that kept ahead of the population expansion in Tokyo. Second, “houses are not used as a vehicle for middle-class wealth accumulation. Traditionally, Japanese homes were demolished and rebuilt every 20 to 30 years… As a result, there are relatively few Japanese homeowners trying to prop up the value of their houses by lobbying the government to restrict supply.”[5] In addition, Japanese policies and attitudes on foreign immigration and ownership of Japanese assets may have also deterred potential global demand.
Hence, the traditional paradigm that relies on household formation to support a buoyant housing demand and economic growth requires a re-visit. In this context, there is a need for a more detailed theoretical framework on the interactions between demographic aging, household formation and the housing market.
References
Barry Ritholtz (11 November 2017) Millennials leave the basement to buy homes. Bloomberg. https://www.bloomberg.com/view/articles/2017-11-10/millennials-leave-the-basement-to-buy-homes
Chava Gourarie (July 2017) “Millennials aren’t the only generation choosing to live with roommates”. The Real Deal. http://www.businessinsider.com/millennials-arent-the-only-generation-choosing-to-live-with-roommates-2017-7
Derek Thompson (24 December 2012) “The most overlooked statistic in economics is poised for an epic comeback: Household formation.” thealantic.com. https://www.theatlantic.com/business/archive/2012/12/the-most-overlooked-statistic-in-economics-is-poised-for-an-epic-comeback-household-formation/266573/
Noah Smith (14 March 2018) “Want affordable housing? Just build more of it”. Bloomberg.com. https://www.bloomberg.com/view/articles/2018-03-14/california-affordable-housing-is-no-mystery-just-build-more
Phuah Eng Chye (10 March 2018) “Organisation of households: Changing household structures and dependency”. Economicsofinformationsociety.com. http://economicsofinformationsociety.com/organisation-of-households-changing-household-structures-and-dependency/
Phuah Eng Chye (17 March 2018) “Organisation of households: Shrinking households, labour market frictions and societal cultures”. Economicsofinformationsociety.com. http://economicsofinformationsociety.com/organisation-of-households-shrinking-households-labour-market-frictions-and-societal-cultures/
Timothy Dunne (23 August 2012) “Household formation and the great recession.” https://www.clevelandfed.org/newsroom-and-events/publications/economic-commentary/2012-economic-commentaries/ec-201212-household-formation-and-the-great-recession.aspx
[1] “Household means is a group of people living together.”
[2] From its peak in 2004. Barry Ritholtz.
[3] Derek Thompson.
[4] Phuah Eng Chye.
[5] Noah Smith.