There Will Be Demand for Housing

Investor Bill Ackman was on CNBC yesterday discussing investments and the economy. He seems particularly bullish on the latter. "I think there's a decent chance that we massively outperform expectations," he told host Andrew Ross Sorkin.

The rationale is simple. Between collapsing prices and record-low interest rates, housing is now more affordable than ever. Factor in rising rental rates, and demand for new homes should rise dramatically. "Once unemployment stabilizes -- which, I think we're heading in the right direction -- all of the sudden people feel comfortable buying a home," Ackman said. That builds momentum that can drive the entire economy higher.

But hold on, warned former senator and co-host Judd Gregg:

How do you factor in the demographics? I mean, we're going from 35 million retired people to 70 million retired people ... the baby boom generation, the generation that basically drove the home market in the '70s, '80s, '90s, and 2000s ... they don't want to buy a home. They'd actually probably like to get rid of the home they're in ... It would seem we don't have the energy to buy homes that we did in the '80s and '90s.

Ackman's reply was, to paraphrase: Yes, but the baby boomers had kids. And they like buying homes, too.

I'd like to expand on that a little.

The baby boom generation was indeed large compared with their parents' cohort. But given the number of kids they had, the U.S. now has a fairly young population:

Age Cohort

Number of Americans (2010)

Percentage of Total Population

<20 83.2 million 27%
20-45 102.7 million 34%
45-70 91.8 million 30%
>70 26.6 million 9%

Source: Census Bureau.

That's important when forecasting housing demand. Over the long run, housing demand rests on one key number: new household formation.

Since 1947, an average of 1.2 million new households have formed every year. New home construction has averaged slightly more -- 1.5 million a year -- for two reasons: Some old and dilapidated homes are torn down every year, and we had massive housing overbuild over during the 2000s.

The bad news: New household formation fell off a cliff when the recession hit. In 2009, just 398,000 new households were formed, the lowest in decades. High unemployment among the young pushed a wave of people to move back in with their parents, and financial strains among older workers caused families to double-up in a single home. According to the Census Bureau, the number of individuals and families doubling up jumped from 61.7 million in 2007 to 69.2 million in 2011, and the number of those age 25-34 living with their parents rose from 4.7 million before the recession to 5.9 million in 2011. That drop in household formation is partly why new home construction plunged (it's now at an all-time low), and why it's been so hard to soak up excess housing inventory left over by the bubble.

Here's how a recent Goldman Sachs research report put it:

Holding headship rates within each age group constant at their 2007 level, growth in the size of the population and changes in its age structure would have warranted annual household formation of 1.3 to 1.4 million per year over the last few years. The reason that actual household formation was only about half that amount per year was a decline in headship rates within age groups -- and in particular, a sharp drop in the headship rate for persons aged 18 to 34.

But the dip won't last. Young folks living in their parents' basement and suppressing the urge to start a family can only handle it for so long. Once jobs bounce back -- and they are -- household formation will come back, too.

In fact, it already is. The Census' latest numbers show household formation hit 1.1 million in 2011, or close to the long-term average. That figure will almost certainly be higher this year and next as pent-up demand from those forced to delay starting a household during the recession get a chance to strike out on their own.

But the big question remains: What will long-term household formation be like going forward? Because that's what drives housing demand.

The good news is that our fairly young population and continuing immigration means it won't be half bad. Here's what Harvard's Joint Center for Housing Studies predicted (link opens PDF) in 2010:

[H]ousehold growth will average about 1.48 million annually in 2010-20. Even if immigration falls to half the Census Bureau's currently projected rate, household growth will still average about 1.25 million annually. This low-end estimate puts household growth in the next 10 years on par with the pace in 1995-2005, and should support average annual housing completions and manufactured home placements of well over 1.7 million units. The higher-end estimate would likely support production exceeding 1.9 million units per year on average over the coming decade.

Goldman sees between 1.1 million and 1.2 million new households formed every year for the next five years, and that assumes a conservative jobs growth of 150,000 a month for the next two years -- below what we've already achieved over the last year.

Bottom line: Despite retiring baby boomers, there will be demand for housing going forward. In fact, it will likely be in line, if not higher, than demand seen over the last several decades.

That's one reason I think homebuilding stocks offer opportunity for enterprising investors, albeit with heavy risk. I've given the green light to MDC Holdings (NYSE: MDC  ) , KB Home (NYSE: KBH  ) , and Meritage Homes (NYSE: MTH  ) , among others, in my CAPS account. I expect all to outperform in the coming years.

Disagree? Let loose below.

Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. Follow him on Twitter @TMFHousel. Motley Fool newsletter services have recommended buying shares of MDC Holdings and Meritage Homes. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (9) | Recommend This Article (14)

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  • Report this Comment On March 09, 2012, at 1:55 PM, Melaschasm wrote:

    I generally agree with this article, but I don't like the chart.

    The age breakdowns should have been something like:

    <20

    20-40

    40-60

    >60

    Going with >60 is better than >70 since it gives a clearer picture of people who are retiring, or will soon retire. I could even argue that we should have a 55 to 70 age range, since these are the home owners who will be downsizing or selling their homes to move into retirement communities over the next decade or so.

  • Report this Comment On March 09, 2012, at 4:37 PM, TDRH wrote:

    Respectfully, have one point that I would like to highlight that was not addressed. The jobs that are "bouncing back" are not increasing the median household income. Interest rates are low, but if half you populations have household incomes of 50k are less your age demographics are not nearly as important.

  • Report this Comment On March 09, 2012, at 11:37 PM, Chontichajim wrote:

    People will adapt to changing conditions even as we age. 20 years ago I would have assumed I would retire with one paid off place to live. Just before retiring with home prices low, rents high, and a house and condo paid off we added a house with mortgage and started retirement. 2 rentals and 1 mortgage are an option over one paid off house. Most retired people have extended families and those families need more help than ever with housing. Our new development has several families of more than one generation contributing to a house.

  • Report this Comment On March 10, 2012, at 1:35 PM, duuude1 wrote:

    Hi Morgan,

    I like your statistics on household formation - and can't disagree on the pressures that are building.

    I have to disagree with you on your prediction, though. I've been a housing bear practically my whole life - and unfortunately continue to be. I'm psyched that you've put your predictions on CAPS for all to see - with all due respect I predict that you'll be in the red unless your picks redirect their business efforts from SF homes into apartment buildings.

    Lots of people want Ferraris - but very very few can afford them so few are actually sold. Demand says nothing about how many of any product will actually be sold. The price of the good has to match the income of the purchaser - and only then does demand play a role.

    In my opinion, much more important to the future of SF homes are the following:

    1. what is the median income of these burgeoning new households:

    http://www.census.gov/compendia/statab/cats/income_expenditu...

    - unfortunately the census stops at 2009, but I am willing to bet that trend has gone down and will continue into the foreseeable future. What was the big increase in business hiring this past quarter - Services! (http://www.bls.gov/news.release/empsit.nr0.htm) Not manufacturing or technology or healthcare...it was services. Since when has cleaning a Motel 6 paid as well as assembling iPods? Since when has bussing tables paid as well as grading roads?

    2. what is the available assets of these housholds:

    http://www.census.gov/hhes/www/wealth/2004/wlth04-1.html

    - unfortunately this stops at 2004 but I believe household net assets today are pathetically low - especially in the new households you are betting on rescuing the housing industry.

    - the availability of cash affects whether these new households can even afford financing (down payment, fees, taxes, commissions, new house purchases and maintenance). We are the worst savers in the world - and with no help from blogs and articles claiming that we are actually saving too much. So these new young households have no savings, no assets, no ability to plan financially. And thus no ability to make major down payments.

    3. what are the financing requirements (minimum down payments, credit ratings, etc)

    - banks will have to tighten their lending standards as legislation comes into play requiring them to retain a larger percentage of loans on their books and (God forbid) actually have to assess the credit-worthiness of their customers

    - Fannie and Freddie are not long for this world, as it should be, and therefore without these massive institutions buying loans, AND with the Fed eventually having to increase lending rates since no one want them to continue "printing money" - right? - the effects of these two macro events will be to spike interest rates through the roof.

    - and when that happens, in order for homes to remain affordable, home prices must drop precipitously - unless we re-institute liar loans and would prefer to have everyone continue the dishonesty all around

    - banking requirements on downpayment and interest rates are directly related to household net assets and income in points 1 and 2

    4. what are the actual median home prices relative to the median incomes

    - this was always the crux of my argument against housing for the past decade - and I believe it is still out of whack - the median home price is still more than 3x median income, and is artificially elevated only because of artificially low interest rates and the presence of Fannie and Freddie continuing to purchase loans.

    5. will home prices continue to plummet and will these new households want to risk losing their capital?

    - historically when people were underwater, I believe the statistics have shown that they have walked. So that means that most people do not like the idea of throwing money away. That is a good thing. It means people are aware and make rational decisions financially. Kids are not dumb. They see their folks underwater. They see that real estate is not the fool-proof investment it has been hyped to be. They will rent. And they will be fine.

    I believe that housing is not coming back any time soon, and our economy will have to advance without it.

    One of my better stock picks was JLL in 2008 through early 2009. I picked up some more when they tanked mid 2011 (but were still double my original purchase price). So I believe it is possible to pick up good real estate plays and be contrarian successfully. But SF homes is not it - yet. Wait a decade.

    Best,

    Duuude1

  • Report this Comment On March 11, 2012, at 12:48 AM, lowmaple wrote:

    >60. There were comments that the retirement age would slowly go up towards 70 to pay for taxes etc.

  • Report this Comment On March 12, 2012, at 3:08 PM, duuude1 wrote:

    Take a look at the comments in these two articles on underwater mortgages:

    http://finance.yahoo.com/news/underwater-locked-130036830.ht...

    http://finance.yahoo.com/news/load-off-fannie-bold-plan-1735...

    When 11 million homeowners get principal reduction on their homes and scoot the heck out of their homes, what kindly, do you think will happen to home values?

    And all those angry posters, when they realize, even if they did buy within their means, but bought anytime in the last decade, not even at the peak of 2006, that their homes are not worth anything like they thought...what do you think will happen then? This problem will just cascade - and this is just one more reasone why I think we are at least a decade out before resolution to this housing mess we are in.

    Duuude1

  • Report this Comment On March 12, 2012, at 3:25 PM, DJDynamicNC wrote:

    @Duuude1 - I've been pushing the multi-unit rentals angle myself and I tend to agree with your assessment.

    One overlooked facet is the fact that household formation hinges partly on social norms. It's possible that we're going to see a shift away from the traditional "move out by 18" norms that most of us on this board are used to. Partly this could be due to economic circumstance - with so many people forced into moving back home after college, moving in with parents, moving in with roommates, and so on, the stigma against multi-family and multi-generational households has faded fast. On top of that, a good chunk of the population growth ahead of us is from immigration. Many other countries have much strong multi-generational and multi-family household norms, and those immigrants may bring that with them.

    I couldn't say how much impact - if any - this will have on the housing market, but it's just one in an array of factors leading me to believe that the multi-unit rental market is likely to be much more sound, at least for the near term.

  • Report this Comment On March 13, 2012, at 11:55 PM, Keebo2 wrote:

    Morgan demographics are king when it comes to housing. But you have to compare apples to apples. You are saying that 25-35 yr olds looking for starter homes, making way less than the boomers, that have college loans, a small 401k ( if any), are going to fill gap and buy up the McMansions that the Boomers are looking to downsize out of?!? Not to mention to get a house you have to have 20% down now, not like the glory days of the 100% sub prime loans. And once someone gets a job, do you think they will magically have a 20% down payment and not have to save for it?!?Yes, the starter home part of the market will come back first. But Honestly, you need to look at the big picture and not tshe basic numbers. I could go on about how ridiculous the optimism is, but I don't see the need.

  • Report this Comment On March 14, 2012, at 6:18 PM, duuude1 wrote:

    And I keep seeing this phrase over and over and over again in articles like this:

    http://www.businessweek.com/news/2012-03-14/southern-califor...

    "Shoppers continued to find bargains with foreclosed homes and short sales, where the price is less the amount owed"

    The phrase should be:

    Shoppers are paying less than what the previous knucklehead paid, but are still paying more than what the underlying asset is worth...

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