Demand for housing has been suppressed in the four-year period from 2007 to 2010. A review of household formation shows an annual increase of 500,000 to 600,000 over these years. A more normal gain would be 1 to 1.2 million each year. (As a quick clarification on households, one household corresponds to one housing unit. A single person living in an apartment is considered one household. A family of five people living under one roof is also considered one household.) Population growth has not slowed, rising consistently by around 3 million each year, but household formation has.
That is due to an increasing number of people deciding, or being forced by circumstance, to live with others. Rather than one roommate, many now have two. Some recent college graduates have returned home to live with their parents. Painful foreclosures have also forced people to find temporary arrangements with friends and relatives.
Living in tight spaces is not sustainable. More people cannot be comfortably shoved into existing households. Aside from the desire to be independent and to move away from temporary living situations, there is the issue of “familiarity breeding contempt,” as the saying goes. It is just a matter of time before household formation returns to its historic normal growth of 1 to 1.2 million each year. There could even be more-than-normal household formation for a few years from both normal population growth and from people leaving temporary arrangements. A stronger economy and job prospects will help in restoring normal household formation.
This suppressed housing demand is like a coiled spring. But when will it pop? This year? Next?
When it does pop there will be a rush of home buyers and renters into the market. Inventory will fall, home prices will rise. Rents will rise. Home builders will need to quickly ramp up production and hire construction workers. Home builders are expected to add only 770,000 new units this year, which is well below the one million new demand from household formation, but still up from the 500,000 range of the past three years.
This concept is the basis for Warren Buffet’s optimistic outlook for housing in last week’s interview.