This is the final segment of the Spotlight series on demographics and implications for housing starts. The purpose of this Spotlight is to shift the focus to the forecast for overall household formation for the next ten years. In addition, it will address the implications of demographic trends for the possible mix of housing starts (single-family vs. multi-family units). Although the level of housing starts is interesting, the really important issue for wood products is the single-family share of those starts. In 2005, housing starts were above 2 million units, but as seen in GRAPH 1, single-family share hit 83%. That put singlefamily starts at a record 1.7 million units. After the bubble burst, not only did the level of starts fall, but the single-family share plummeted, dropping below 65% in 2015. The massive decline in single-family starts led to a 22 billion board feet decline in lumber demand—roughly 70% of the overall decline from peak to trough.
In the previous Spotlights, we focused primarily on the younger adult population—ages 25-44. This population wave will have a profound influence on the demand for housing over the next decade. This is a period when people typically get married, have children and buy their first home. As suggested in Parts I and II, there are reasons to believe that the annual household formations (HHF) for this age group might fall far below what had been expected a few years ago.
In Spotlight Part I, the focus was on the significant decline in labor force participation rates (LFPR) of younger adults. The biggest change has been in the LFPR for young men. That decline could be permanent and, if so, would lower HHF for young adults over the next ten years. The decline could also contribute to a decline in the marriage rate among young households.
In Spotlight Part II, a plausible range of HHF for young adults was proposed. (Unfortunately, we had to walk readers through the painful part of household formation forecasts— estimating population and the propensity to form households by age group.)
Two things could lower the forecast for HHF. First the headship rate (the ratio of the population to households— which is a proxy for the propensity to form households) had declined between 2006 and 2016. The declining LFPR suggest that the decline could continue even though the job market has improved. Second, a significant cut in immigration would reduce the growth of the young adult population in the Census Bureau’s Reference forecast—which was released in 2014.
Overall household formations: dominance of the over 65 population group
As we discussed in Spotlight I, there are two population waves. We have spent a great deal of time on the wave of younger adults. The Baby Boom wave (adults born between 1947 and 1962) is the other major surge. They are now leaving the 55-64 age group and moving en masse into the over 65 category. The front end of the age group became 65 in 2012.
The dramatic growth in the HHF for the older age group is due to several factors:
- First, the over 65 population wave is already in the country. The growth does not depend on immigration. The primary uncertainty is the assumed mortality rate. This population group is forecast (by Census) to grow about 1.9-2.0 million per year over the next decade. This compares to a population growth of only 0.4 million per year for the 25-44 age group.
- Second, the headship rate for the older age groups has been more stable over the last ten years. The headship rate moves above 0.5 for the over 55 age groups, primarily because of divorce or death of a spouse. A headship rate of 0.5 means there is one household for every two adults. When a spouse dies, and the survivor remains alone, then the headship goes up.
The combination of the population surge plus the rising headship rate is why HHF for this age group will be near one million per year over the next ten years. The really striking shift is share of total households that will be over age 65. In the housing boom period of 2001-2005, only 14% of HHF were over age 65. The share moved higher in 2006-2010 in part due to the decline in HHF for younger adults. The over 65 age group currently accounts for about 70% of HHF. After 2020, this age group will account for about 90% of net households in the Base Case.
But share will be even higher if the HHF for younger adults falls into a lower range. Total HHF would be much lower—1 million per year or lower. If so, trend housing starts would only be 1.3 million per year or possibly lower. Even more dramatic is the share of the over 65 group. The over 65 group could account for more than 100% of household growth after 2020. The industry currently is focused on the needs of the millennials. That will change after 2020.
Demographics and the mix of housing starts
So, this brings us back to what the mix of housing starts will be over the next ten years. The purpose of housing starts is fairly simple. First, they expand the inventory of housing to accommodate the growth in households. Second, they build units that might not be available if the household needs have changed. Third, they replace units that are removed or destroyed. Finally, starts also shift the inventory to a region that is growing and needs more housing inventory.
The type of housing a household will want to occupy depends on both economic and lifestyle issues. For instance, younger adults tend to rent an apartment for economic or lifestyle reasons. They don’t need a down-payment and are able to move more easily if they change jobs. When children enter the picture after marriage, owning a single-family unit is preferable.
The rise and fall of the ownership rate is closely tied to the rise and fall of the single-family share. The ownership rate rose on a consistent path from the mid-1990’s level of 64%, peaking in 2005-2006 at 69%. Although a rise of 5% may not seem that big, you have to remember that with an occupied housing stock over 110 million units, a 1% rise in the ownership rate means you have to add over 1.1 million singlefamily starts to just accommodate the shift in ownership. (Most owned units are single-family units, not condos.)
The aging of the population, extremely easy lending standards, public policy goals and expectations of higher home prices fueled the dramatic rise in the ownership rate and the single-family housing starts boom.
The causes of the boom and bust in the ownership rate has been addressed a number of times before and will not be dealt with here. Instead, the focus is on what might happen next. To do this, let’s dissect the ownership rate surge and bust by age group. The ownership rate for the young adults peaked in 2005 and then the correction hit these groups particularly hard. The foreclosure of loans they could not afford, followed by the tougher lending standards, pushed the ownership rate for the 25-44 age group down by 10% from 2005-2016.
There are several important takeaways when considering ownership by age group that are crucial to the outlook: First, ownership rates rise with age. There is a big rise in the ownership rate as adults age. The biggest jumps happen between age 25 and age 45. Thus, despite the decline in the ownership rate, the movement of the younger adults into the 25-34 group in the current period and then into the 35- 44 group after 2020 will help boost the average ownership rate over the next decade.
Second, the ownership rate for the over 65 age group is near 80% and has been relatively stable. The growth in the age group will help boost the overall ownership rate as well. This is partially offset by the decline in HHF for the 55-64 group after 2020. In the early retirement period, people prefer to stay in their current home. After a spouse dies however, the survivor eventually moves to a smaller house, a condo or an apartment (the ownership rate for unmarried people is below 70%, but still high). When this group approaches 75 (after 2025) the focus begins to shift to housing units that are easier to maintain, do not have stairs or includes some medical and living assistance.
Third, the aging population will also affect where housing units are built. Many older adults prefer warmer climates. The aging group likes to spend at least part of the year in Palm Springs or Florida.
Thus, the base case demographic trends favor a rebound in the ownership rate and the single-family share over the next five years. This is consistent with the current base case outlook for FEA housing starts.
Three factors that could dampen how big the upward trend will be:
- The actual annual HHF of the younger age groups could be significantly lower.
- The declining share of married households for younger adults has contributed to the decline in ownership rates. This is shown in GRAPH 2 for the under 35 age adults. You should note that the ownership rate for a married couple is near 55%, while the overall ownership rate is only 35%.
- The share of married households declined from 44% in 2000 to about 35% in 2016. This is one reason why the ownership rate fell by 10% and could still be falling.
The marriage and ownership trends for the 35-44 age group is a bit more encouraging. As seen in GRAPH 3, the marriage rate for this group fell only 4%. The ownership rate for married households is also much higher at 75%, while the average for the entire group is below 60%. Good news here: The ownership rate for the 35-44 group appears to have hit bottom.
Finally, the ownership and housing start outlook depends on interest rates. The current outlook for interest rates assumes that higher rates will not do too much harm until later in 2019. However, there are storm clouds on the horizon given the Fed’s likely actions combined with the expected surge in the Federal budget deficit over the next three years.
Bottom line: Housing demand was hit hard by the demographic events of the 2006-2014 period. The sharp decline in both HHF and ownership rates for younger households played a key role in the extremely large decline in housing demand and in the share that were single-family units. Those trends for this key group are now much more favorable. HHF are moving back to the 1.2-1.3 million level which is consistent with housing starts at the 1.4-1.6 million range. The ownership rate has bottomed and will continue to improve. Finally, the recent improvement in the single-family share should continue for another few years, but probably will not exceed 80% again.