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Home Price Gains Explained in Part by Household Formation Trends
We’re regularly reminded of the lack of homes for sale and the shortfall of new housing construction in America, but is the shortage consistent across the country? If there are meaningful differences, how do they affect home prices? To answer these questions, we turned to the recently released results from the American Community Survey (ACS), which is administered annually by the U.S. Census.
U.S. Household Formation Slows
The ACS data include estimates of the number of households in metropolitan statistical areas (MSA); by comparing these data across years we can understand how quickly cities are growing or shrinking. Examining the data, we can see that as a whole the U.S. added 652k households in 2016, a considerably slower pace than the 949k households established in 2015, but closer to the average rate of 712k seen from 2006-2015.
On the MSA level, we should note that the majority of the large homebuilding markets tracked by Housing Tides experienced household growth in 2016. However, there were significant local variations, with the Dallas-Fort Worth-Arlington, TX MSA adding over 58k households in 2016 while the New York-Newark-Jersey City, NY-NJ-PA MSA had a net loss of 7k households.
Comparing Housing Permits and Household Growth
While household growth is a primary driver of housing demand, the primary source of supply is new housing permits. By comparing net household growth to the number of new residential building permits we can discover how closely housing supply has matched housing demand. Our measure of choice is: Housing Permits – Net Household Growth. If this measure is negative, then household growth has exceeded new construction, which should put upward pressure on home prices, all else equal. If this measure is positive, it means that more homes were permitted than new households were formed, indicating that supply will likely exceed demand.
Hypothesis: Construction Deficit Drives Rising Home Prices
We hypothesize that MSAs where household formation surpasses housing construction experience outsized home price gains. But how did this hypothesis play out in reality? Of the major metros tracked by the Tides team, we narrowed the list to those MSAs where we have data from the S&P CoreLogic Case-Shiller Home Price Index. We found that there was a negative correlation between our measure of construction suitability and home price growth. In other words, housing construction that outpaced household growth was associated with lower house price appreciation.
Seattle Home Prices Appreciate Faster than New York
For example, the New York City MSA, which experienced a net loss of over 7k households but approved 49.5k building permits, saw home price appreciation of just 3.1% in 2016. On the other hand, Seattle household growth outpaced construction, with 25.5k homes permitted but 27.7k new households formed, and home price appreciation topped 10.7% for the year.
Why It Matters
This conclusion might seem obvious, but it has implications for cities like San Francisco and Los Angeles, where the high cost of housing, and the high cost of living generally, has many considering relocation. The worry is that high housing costs could drive people to leave those cities at the same time that residential construction ramps up, with the ensuing gap between household formation and home construction resulting in stagnating or even falling home values. To be sure, this would be beneficial to cost-burdened low-income residents but may come as a surprise to investors or homeowners that expect home prices to appreciate indefinitely.
What’s Up With Denver?
A notable outlier, Denver showed a high rate of price appreciation despite housing permits that exceeded household formations in 2016. One possible explanation is that, according to ACS data, the homeownership rate in Denver increased by the second-largest margin among the 19 cities included in this analysis, rising from 62.9% in 2015 to 63.8% in 2016. When a household converts from renting to owning, this is not counted as a household formation and as such represents purchase demand that is not captured in the household growth data. With Denver yearly multi-family housing permits topping 10k for the first time in 2016, one could argue that purchase demand outpaced purchase supply in Denver, which is reflected in the strong Case-Shiller appreciation figure that measures sales prices and does not include rents. To this point, Census data show that Denver permits for single-family houses and townhomes totaled just 10,587 in 2016 while the MSA added 19,669 homeowner households.
Conclusion: Household Growth Matters
Still, overall we can conclude that the markets where household growth exceed new home construction tend to have the fastest rates of price appreciation – with this observation it’s clear that any expectations of home price appreciation in major U.S. cities would benefit from a comparison of residential construction totals and household formation trends.
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