Many are giddy about the rise in home prices. Yet gains in home prices with no subsequent gain in income are merely a repeat of the previous bubble with a different tune. In the last bubble, the memory has seemed to faded, the impetus for funky loan products came because incomes were not rising and products that offered additional leverage were taken up to mask the growing decline of wages. In the last couple of years, the tinder that lit this latest run came from the Fed’s artificially low rate eco-system. The difference this time is that the gains in home prices largely went to big investors that now dominate the market. In the midst of all this trading, the homeownership rate has fallen. Household formation for younger Americans is dismal. The economy officially exited the recession back in the summer of 2009 (half a decade ago this summer). So why is housing formation so weak when it comes to younger households if the economy is supposedly booming?

Household formation – Under-performance



There was an interesting presentation made by Andrew Paciorek and was posted over at the Fed’s Atlanta website. The gist of the analysis attempts to examine the math behind the weak growth in housing formation.

One main reason that I have argued is that many younger households are simply saddled with large amounts of debt and weak incomes.

First, let us look at the math behind housing formation:

From 2000 to 2006, roughly 1.35 million households were forming per year. This baseline may be inflated given this was at the meat of the first housing mania. But let us use that as a baseline. Then, with the real estate crisis, housing formation hovered around the 550,000 range. That is a massive drop. What happened here was the yanking of maximum leverage loan products that really did not care about the borrower’s ability to repay the loan (i.e., their income). When that was put back into place, the market corrected fiercely since many were walking on eggshells hoping the bottom didn’t give out.

In 2012 household formation recovered to 1 million per year. This came because the vanilla 30-year rate collapsed and also, prices sinking made it more affordable for families to venture out and buy. The slide above mentions that housing didn’t jump start the recovery but I disagree. Investors plowed into the market. They jumped in with generous liquidity provided by the QE system. Investors went from something like 10 percent of all sales to well over 30 percent of all sales. A reader made an astute comment that items for the 1 percent are doing exceptionally well (i.e., luxury cars, food, and clothing) while items for the general population are taking a big hit (i.e., JC Penny, etc). Investors are buying homes with non-traditional financing largely unavailable to the general public. Indirectly, the rise in home prices has now created a wealth effect yet again:

Source: CoreLogic

These are some incredibly large year-over-year gains especially when incomes remain stagnant. So what you really see for many is that more income is going to housing in the form of higher mortgages or higher rents. Of course who gets these higher payments? Big investors that are now a big portion of the single-family housing market. So yes, the real estate market is once again front and center for this recovery yet this recovery is largely leaving out the middle class.

Household formation – Living with the parents

The other more obvious point is a larger portion of younger Americans now live at home with parents. In California, it isn’t uncommon to see multi-generations live in one household either out of saving money or necessity. This trend is undeniable across the nation:

In the early 1980s, about 36 percent of young adults lived with older family members while today it is up to 46 percent. Keep in mind this happened during the so-called recovery. Yet from 1990 to 2008 the pattern held around 40 percent. Why? Because young households bit the bullet and took on maximum leverage loans either the vanilla variety or of the more exotic kind like ARMs. The results were disastrous since 5.4 million homes have been repossessed since the real estate bust hit. Yet investors have been gobbling up these homes at distressed prices and leveraging the low rate eco-system developed by the Fed.

The reason for the lag

This answers a couple of points as to the lag in household formation from the young but the bigger point is jobs (or good jobs to be more precise) and income. Let us look at the conclusion of the presentation first:

I agree with the three underlying factors of formation. The third point is given very little attention. The labor market for younger Americans, even college graduates is not as positive as to justify current home prices:

Wage growth for college graduates has fallen. A large reason for home price increases has been a simple supply and demand equation. You have very little supply being metered out by banks and you have investors dominating the market (up to 50+ percent in Arizona and Nevada and over 30+ percent across the nation). Recall those massive price gains in home prices? Well now you have only 1 out of 3 households that are able to afford a home in California. The question of household formation strikes at a new issue in that this next generation is likely to have a tougher go at the economy than the baby boomers. In California for example, you have baby boomers that went to state universities when competition was not as fierce and the price-tag was virtually free plus the added bonus of the Prop 13 lottery that hit in 1978. Then, exiting into a job market that is nothing like the one today (and pensions were abound even in the early 1980s with low healthcare costs). Throw in the record bull market in stocks and you have a healthy combination of luck, timing, and fortune meeting together. Today I have talked with 2 income households where both are college educated professionals making good incomes and they are struggling to purchase a modest home in a decent neighborhood without throwing most of their net income at the mortgage.

The household formation question is an interesting one but I seriously doubt that young Americans are going to be part of the new real estate renaissance for a few years. Many are actually getting conditioned to enjoying renting and the employment mobility that is more part of the economy today compared to the lifetime employment of a generation ago. The facts are clear and that is a larger portion of younger Americans are living at home for some reason and not venturing off to launch on their own.

Did You Enjoy The Post? Subscribe to Dr. Housing Bubble’s Blog to get updated housing commentary, analysis, and information.