The U.S. economy lost more than 1 million households during the recession, even as the population grew more than 3.5 million, driving down home ownership and increasing rental vacancies at a rate that hasn’t been experienced in more than a generation.

Just as economic distress reduced households, economic recovery will increase households, concludes USC professor Gary Painter in a paper sponsored by the Research Institute for Housing America, a mortgage industry-backed think-tank.

As you read through What Happens to Household Formation in a Recession?, it becomes clear that the rebound in household formation will greatly benefit the rental market, while the impact to the residential real estate market will be more muted.

Finally, it will be important to observe a turnaround in home ownership rates before the housing market is likely to stabilize. This is because increases in initial household formation will disproportionately come from renters, which may cause home ownership to fall further. In addition, former homeowners who lost their homes due to foreclosure have had their credit damaged and will likely take time to repair their scores and secure a down payment. Once both of these classes of renters make the transition to home ownership then we would expect the housing market to stabilize.

Painter provides one of the most complete analyses of available data to capture what happens to households during changes in the economy. The graphic below illustrates the dynamic of households. During periods of economic stress and increased unemployment, more people combine households and fewer people leave existing households.

household formation model.png

Declines in employment and increases in the unemployment rate during periods of recession reduce household formation rates. Specifically, a national recession suppresses the formation of new renter households, while higher unemployment rates suppress the formation of both new renter and owner households.

The remarkable thing is how much those numbers add up: in all, a net decrease of 1.2 million households during the recession, Painter estimates.

The model…using data covering 6 recessions, predicts that rental household formation likely fell by 2–4 percentage points due to the current recession and that the formation of owner households likely fell by about 1 percentage point. Confirming these predictions, data from the ACS shows that formation of native-born households in a sample of 80 of the largest metropolitan areas has fallen by about 3 percentage points overall and by nearly 4 percentage points in the largest immigrant gateway metropolitan areas. This translates into a reduction of nearly 1.2 million households nationwide during a period where the population in these metropolitans grew by 3.4 million.

These figures help to explain the significant pressure on the residential home market and on the rental market.

As the table below demonstrates, the drop in home ownership that began in 2004 was accompanied by a sharp increase in vacant homes.

homeownership trends.png

At the same time, occupancy of rental units has decreased to generational lows, leaving one to wonder, Where have all these people gone?

Last month, Pew Research Center released data showing that multi-generational households — two or more generations sharing a home — had increased to 16% of the population during the recession. In raw numbers, this means that 7 million more people were living in multi-generational households in 2008 than were in 2000.

multigen hhs.png

That creates a depression of demand. Add in the glut of inventory that was created to satisfy the temporary demand of the housing bubble, and you’ve got the kind of discontinuity that drives down prices and disrupts the orderly progression of markets.

Interestingly, Painter shows that the elimination of households was disproportionately concentrated among native-born Americans, and particularly among households that had moved in during the recession.

homeownership rates by category.png

The good news in Painter’s analysis is that the signs of a rebound in household formation are apparent in his model.

The model suggests household formation should increase by about 2 percentage points from current levels by 2012, as people find jobs and recession-induced anxieties abate. That would imply that by 2012, normal rates of household formation should reappear (roughly 1–1.5 million new households per year), but it will take even longer before the U.S. completely recovers from the deficit in household formation caused by the severe recession.

As noted above, the first market to benefit from the gain will be rentals. The residential home market should recover more slowly, Painter argues.

To the degree that the economy rebounds more strongly, the recovery will be more rapid. The mystery of increased demand isn’t unsolvable: the dynamics that drive household formation need to reassert themselves, and the core drivers are jobs and incomes.

You can find the full report available for download here.

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