Saturday, October 03, 2009

The Impact of the Declining Homeownership Rate

by Bill McBride on 10/03/2009 05:00:00 PM

This is an update to a 2007 post: Home Builders and Homeownership Rates1

From 1995 to 2005, the U.S. homeownership rate climbed from 64% to 69%, or about 0.5% per year.

Homeownership Rate Click on graph for larger image in new window.

The first graph shows the homeownership rate since 1965. Note the scale starts at 60% to better show the recent change.

The reasons for the change in homeownership rate are discussed in the 2007 post ( a combination of demographics and changes in mortgage "innovation"), but here are two key points: 1) During the boom, the change in the homeownership rate added about half a million new homeowners per year, as compared to a steady homeownership rate, 2) the homeownership rate (red arrow is trend) is now declining.

The U.S. population has been growing at close to 3 million people per year on average, and there are about 2.4 people per household. Assuming no change in these rates, there would be close to 1.25 million new households formed per year in the U.S. (The are just estimates, and fewer households are formed during a recession - a key problem right now).

Since about 2/3s of all households are owner occupied, an increase of 1.25 million households per year would imply an increase in homes owned of about 800K+ per year. If an additional 500K per year moved to homeownership - as indicated by the increase in the homeownership rate from 1995 to 2005 - then the U.S. would have needed 1.3 million additional owner occupied homes per year.

Important note: these number can't be compared directly to the Census Bureau housing starts and new home sales. There are many other factors that must be accounted for to compare the numbers.

During that same period, since about 1/3 of all households rent, the U.S. would have needed about 400K+ new rental units per year, minus the 500K per year of renters moving to homeownership. So the U.S. needed fewer rental units per year from 1995 to 2005.

Rental Units The second graph shows the number of occupied (blue) and vacant (red) rental units in the U.S. (all data from the Census Bureau).

Sure enough, the number of rental units in the U.S. peaked in early 1995 and declined slowly until 2005. The builders didn't stop building apartment units in 1995, instead the decline in the total units came from condo conversions and units being demolished (a fairly large number of rental and owner owned units are demolished every year).

Even though the total number of rental units was declining, this didn't completely offset the number of renters moving to homeownership, so the rental vacancy rate started moving up - from about 8% in 1995 to over 10% in 2004.

Since 2004 there has been a surge in rental units. Most of this increase is not new apartment buildings, rather a combination of investors buying REOs for cash flow, condo "reconversions", builders changing the intent of new construction (started as condos but became rentals), flippers becoming landlords, or homeowners renting their previous homes or 2nd homes instead of selling. This increase in rental units is more than offsetting the decline in the homeowership rate, and the rental vacancy rate was at a record 10.6% in Q2. (and will probably be over 11% soon because of the "first-time" homebuyer tax credit).

This increase in the homeownership rate, from 1995 through 2005, meant the homebuilders had the wind to their backs. Instead of 800K of new owner demand per year (plus replacement of demolished units, and second home buying), the homebuilders saw an additional 500K of new owner demand during the period 1995 to 2005. This doesn't include the extra demand from speculative buying. Some of this demand was satisfied by condo conversions and owner built units, but the builders definitely benefited from the increase in homeownership rate.

Looking ahead, if the homeownership rate stays steady, the demand for net additional homeowner occupied units would fall back to 800K or so per year (assuming steady population growth and persons per household). However the homeownership rate is declining, and this is now a headwind for the builders.

It appears the rate is declining at about 0.5% per year. This means the net demand for owner occupied units would be 833K minus about 500K per year or about 333K per year - about 25% of the net demand for owner occupied units for the period 1995 to 2005. (Not including replacing demolished units and 2nd home buying).

Although we can't compare this number directly to new home sales (because of 2nd home buying, replacement of demolished units, and other factors) this does suggest new home sales will probably remain at a low level until the homeownership rate stops declining.

New Home Sales and RecessionsThe third graph shows New Home Sales for the last 45 years. the Census Bureau reported: "Sales of new one-family houses in August 2009 were at a seasonally adjusted annual rate of 429,000."

Once the homeownership rate stops declining - probably at about the same time the excess existing home units are mostly absorbed - new home sales will probably increase to a steady state rate based on population growth. However this level will be substantially below the average for the period from 1995 to 2005 when the homebuilders benefited from the increasing homeownership rate.

The "first-time" homebuyer tax credit (and new homebuyer tax credit in California) probably boosted new home sales a little this year, so the homeownership rate might increase in the 2nd half of 2009. However that increase will probably be temporary, and the homeownership rate will probably start declining again.

Key points:

  • New Home sales will probably remain at a low level until the homeownership rate stops declining.
  • Once the homeownership rate stops declining, new home sales will increase to a steady state rate based on population growth - but far below the levels during the housing boom.
  • Residential investment (a usually engine of recovery) will not provide much of a boost until the homeownership rate stops declining - that will probably happen when the excess existing home inventory is mostly absorbed.

    1 A special thanks to Jan Hatzius. Several of the ideas for this post are from his piece: "Housing (Still) Holds the Key to Fed Policy", Nov 27, 2007
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