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  1. Home
  2. / Investing
  3. / Economic Data

Household Formation Is Cratering

The bump in housing activity is being driven by a small, affluent group.
By ROGER ARNOLD Aug 21, 2013 | 06:00 PM EDT

One of usual prime drivers of housing activity and of the economy overall is the rate of household formation. Household formation has been rapidly declining over the past few years. This is a bad harbinger not only for the housing sector but for private-sector economic activity and the stock market in general.

Investors are used to looking at auto and home sales as indicators of consumer confidence, because these factors are reported on by the companies involved and by various government and private-sector reports.

The idea is that only people who are confident about their income potential buy houses, since mortgages require a call on that future income. People who are unsure of their incomes don't buy homes.

More important is that most home purchases are made when households are formed; in most cases, that is also a sign of confidence.

Households are formed when children move out of their parents' homes, get married and have children, and also when they get divorced and take up separate residences. People who lack income or who have income but lack confidence about that income don't start families and may not leave their parents' homes.

After the housing crash and subsequent financial crisis of 2008, household formation crashed and actually went negative in mid-2009. From that point forward, household formation began to rise again, peaking at just shy of 2 million per month in early 2012, which is about where it was at the height of the housing bubble in 2005.

In the last year and a half, however, the rate of household formation has declined steadily and rapidly to about 335,000 per month.

Households are not being formed because jobs are not being created that would allow for children to exit their parents' homes with the income necessary to pay for their own. Unemployed youth also do not get married.

The fact that this decline in household formation and lack of job creation is occurring simultaneously with a rebound in housing activity would appear to be odd, at first.

In reality, housing activity has been reflecting purchasing activity by investors, both individuals and organizations, who are intent on providing rental housing to the generations of people behind them who do not have the income confidence to form a household or purchase a home.

According to Goldman Sachs, more than half of all home sales in 2012 and 2013 have been to cash buyers. This is an increase from the multi-decade trend rate of about 20% before the housing, mortgage and financial crisis. The last time cash buyers represented the majority of the housing purchase market was before President Franklin Delano Roosevelt created the Federal Housing Administration in 1934.

The germane point of this for investors to consider is that profound changes in the social and economic structure of the U.S. are occurring over a very short period of time. We need to try to determine whether these changes are permanent or long term or whether this is a short-term phenomenon, a residual effect or echo of the financial crisis of 2008 that will resolve itself in short order.

I don't know the answer to that.

What is more apparent, though, is that participants in the financial market do not seem to be aware of these dynamics and the impact they are having on the housing sector right now.

There aren't that many cash buyers or people or organizations capable of accessing cheap debt capital to leverage into residential real estate. As the cost of that debt has risen dramatically recently, it is logical that they have little interest in taking on new, higher-costing debt, after the cost of the underlying physical collateral has also increased in the past year.

The bottom line is that the increase in housing activity in the past year has not been broad-based, nor has it resulted from a rebound in economic activity. It's been driven by a small portion of the society that has the cash and credit available to capitalize on the situation.

That money has now been put to work, but the stocks of companies involved in the real estate space are reflecting expectations that these one-off events are recurring ones.

At some point soon, traders and investors will realize this mistake. 

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TAGS: Economic Data | Investing

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