What Happens to Household Formation in a Recession?
Posted: 1 Dec 2010
Date Written: November 29, 2010
The present economic downturn has been, by many measures, the most severe since the Great Depression. The housing market has been buffeted by large declines in real house prices, caused in part by the collapse of the housing finance system and by continued job losses. While the difficulties in the housing market are nationwide, some areas (Arizona, Florida, Nevada, and California) have experienced much steeper declines in home prices and overall housing market activity. The national homeownership rate has declined from a peak above 69 percent to just over 67 percent, with homeownership rates for some minority groups falling to an even greater extent. At the same time, homeowner rates have increased markedly over the past few years with no corresponding decrease in rental vacancies. This naturally begs the questions: Where have these households gone? One possibility is that households who have lost their homes have moved in with other households, or that households that might have formed during normal economic times, have decided to delay their entry into the housing market. This study provides a comprehensive analysis of the role of the economic cycle and labor market and housing conditions on household formation. New households can be formed either when children move out of their parents home, when couples separate, or when unrelated individuals choose to live singly after previously sharing a residence. The number of households can decline if two households combine, either through marriage, or by sharing a residence to reduce housing costs. In the current environment, household formation rates may well be depressed both because fewer young households are heading out on their own, and because established households are combining to lower costs or due to the loss of homes through foreclosure. In order to better understand the factors that lead households to establish their independence and to understand the role of the present economic environment, I have taken the following three-step approach: Development of a Behavioral Model: The first step is to determine the economic and demographic factors that influence young people to form new renter or new owner households. In order to do this, I use the Panel Study of Income Dynamics (PSID), which follows a large number of households over a long period of time, 1968-1999. Using these data, I determine which factors have influenced young people to form new rental and new owner households over time. o Not surprisingly, the decision to form a household is influenced by economic conditions. During recessions, young households delay entry into the housing market, and remain living with their parents. Other households may choose to share housing costs by combining households, leading to an increase in overcrowded dwellings. o I find that 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. Simulation: Using this behavioral model, I then simulate the likely impact of the current recession on household formation rates. o Simulations suggest that these declines are quantitatively important. For example, in a recession, the likelihood that a young adult will form an independent household falls by up to 4 percentage points depending on the age of the person, and severity of the changes in unemployment rates. By way of comparison, if an individual is unemployed, the likelihood of leaving the parental home is up to 10 percentage points lower. Detailed Analysis of the Current Environment: Finally, I utilize the American Community Survey (ACS) to compare 80 metropolitan areas in 2005 and 2008 with respect to mobility rates, overcrowding rates, homeownership rates, and household formation rates. With this much larger data set, I am able to highlight additional detail regarding the current environment that is not available in the PSID. In particular, I focus on the differences in patterns of household formation between immigrants and native born households. I also closely examine the tenure choices of households that move. Given the analysis above, we would expect headship rates to have fallen, the rate of overcrowding to have risen, but an indeterminate impact on homeownership rates due to the fact that homeownership rates are influence by the relative speed at which the headship rates of potential owners and renters are depressed. o Headship rates, a measure of the ratio of independent households to the population, have declined across metro areas, and across both native born and immigrant households. The impacts of the recession have been smaller in the smaller metros. These declines have been greater among native born households, although the rates for immigrant households have fallen as well, albeit from a lower starting point. o The recession has caused a dramatic increase in the rates of overcrowding, particularly in the emerging gateway metro areas, and particularly among native born households. This clearly indicates that many families are doubling up in response to the downturn. o Overall, homeownership rates declined slightly for native born households in these metropolitan areas, and increased slightly for immigrants in the same areas. Both groups experienced slight declines in the large immigrant gateways, but immigrants actually increased their homeownership from 2005 to 2008 in the emerging gateways and in the smaller metropolitan areas. Overall, these data are suggestive of the fact that there were bigger declines in the rates of rental household formation than in the rates of owner household formation during the recession. o Overall mobility rates declined over this period. However, households that did move were more likely to rent in their new location. The model estimated in the PSID, 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 American Community Survey shows that household formation among native born households has fallen by about 3 percentage points overall, and by nearly 4 percentage points in the largest immigrant gateway metropolitan areas. These results have important implications for both public policy and housing industry professionals. First, the results suggest that the demand for multifamily housing was hit the hardest in a recession. This is evidenced by both the reduction in overall headship rates, and the only slight reduction in homeownership rates from 2005-2008. Second, in this recession, the homeownership rate likely declined due to people losing their homes, but part of the decline was mitigated by the decline in the formation of renter households caused by the recession. Finally, it is clear that we will need to observe a turnaround in the homeownership rates of movers before the housing market is likely to stabilize.
JEL Classification: R2
Suggested Citation: Suggested Citation