Another Reason For Those Empty Houses

Misreading demographic trends led builders to get ahead of demand

During the boom, homebuilders justified their construction frenzy in part by saying they were simply meeting fast-rising demand, particularly from young married couples, the newly divorced, recent immigrants, and others who needed places of their own. Indeed, in the year ending in June, 2006, Americans formed 1.6 million new households, with a household defined by the U.S. Census Bureau as a group of people living together in a house or an apartment.

But the nesting spree was not sustainable. A July 27 Census report shows a 44% drop in the number of new households formed in the year ended in June, 2007, to only 891,000. That's below the five-year trend of 1.1 million to 1.2 million new households per year. The sudden plunge in household growth helps explain why players ranging from builders and subprime buyers to banks and hedge funds are in such trouble these days—and why the weak housing market could last for years.

True, the fall in household formation isn't the only reason housing turned soft. In the short run, the link between demographic shifts and demand for houses can be affected by all kinds of factors, including interest rates, overall economic conditions, and how many people are buying extra homes for speculation.

In the long run, though, demand for housing tracks pretty closely with trends in marriages, births, immigration, and income growth. It appears now that builders misread the evidence and built at a pace above the long-term demographic trend. "The influx of investors and speculators was much, much bigger than anybody appreciated at the time," says David Seiders, chief economist for the National Association of Home Builders.


Now it's payback time. It is likely to take two to three years, by various estimates, for the excess supply to be soaked up. The boom stole sales from the future as people bought houses earlier than they might have a few years ago, says Dowell Myers, a professor of urban planning and demography in the School of Policy, Planning, and Development at the University of Southern California. Says Myers: "The pressure has to rebuild from people who have crossed critical life thresholds and need a home." He estimates it will take about three years for house purchases to get back up to the demographic trend line.

To understand the impact of the slowdown of household formation, just look at the data. According to the Census Bureau, the number of vacant houses and apartments soared by 1 million in the 12 months that just ended. These additional vacancies are a major force pushing down home prices.

If Americans had continued to form households at their rapid pace of the previous year, 700,000 more homes would have been occupied. Vacancies would have risen by a manageable 300,000, and housing would be merely slumping rather than crashing.

Builders are belatedly correcting their overbuilding mistake by slashing construction, which ran at more than 2 million units started per year in late 2004 and 2005. New-home starts are now at a rate of around 1.5 million units a year—but even that might not be low enough to clear up the mess quickly if household formation stays at its current depressed level.

In fact, the combination of tighter mortgage standards, fear of buying a house only to see its price fall, and general housing-related jitters may discourage people from going out on their own. That's the reverse of what happened in recent years, when the prospect of home appreciation lured many people into the market. So homebuilders looking for new customers may have a long wait.

By Peter Coy

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