What is California’s pent-up demand? By: Selma Hepp, Ph.D., Senior Economist
California Association of Realtors, Research and Economics
As the housing market shows signs of improvement, a looming question keeps repeating: What is the size of pent-up demand? Answering that question is not easy. It requires some counterfactual assumptions, such as “what would be if it wasn’t this?” To answer the question, however, we could look at some trends that persisted prior to the recession and project them forward. Housing demand, among other things, depends on household formation. New households result from adult children leaving parents’ households, singles or families leaving shared housing arrangements and creating their own. As suggested by other research, slowing of household formation has been concerning. While, household formations generally slow during recessionary periods, this recession has created particularly hard situation for new household formation. The situation is especially acute among the younger generation leaving colleges who have, instead of starting their own households, moved back in with their parents.
This article attempts to estimate loss in household formation as a result of the Great Recession. Figure 1 illustrates the household growth in the United States and California since the year 2000. Households here are defined as occupied housing units and data is obtained from the Current Population Survey. What is immediately evident is the drop in the number of households in California, following the housing bust. Across the nation, while household formation slowed significantly, it still continued to grow.
Historically, U.S. households have been growing at about 1.5 percent annually. In 2008, however, household formation rate halted at about a third of a percent. In the following years, household formation was about half a percent. In California, household formation rate has been much less steady. It has oscillated from 3 percent growth in 2004 to a three-quarter percent decline in 2010 and is projected to decline over 2 percent in 2012. On average, though, household growth rate between 2000 and 2008 in California has been about 0.85 percent, less than 1 percent average in the decade prior. Since 2008, the rate has averaged -1 percent.
Click On Image for larger View Source: Source: Current Population Survey/Housing Vacancy Survey, Series H-111; California Department of Finance: Current Population Survey
One way of estimating the housing pent-up demand is to look at what household formation would be at today had there not been for the economic and housing crisis and ensuing slowdown. Keep in mind that this admittedly crude method does not consider the current constrained housing financing situation, unemployment, and other factors limiting formation of a new household. The estimate is illustrated in Figure 2. Total population in California, represented by red line, shows to have continued growing despite the decline in the number of households, represented by the blue line. The growing population also highlights that the issue of slowing household formation is not due to falling population in the state.
The estimate suggests what the number of households would be if they continued forming at the national rate observed after 2008, 0.55 percent. As noted, household growth in California has actually declined 1 percent annually since 2008. Thus, if household formation in California followed the national trend, there would be around 575,000 additional households formed in 2012 (see dotted blue line). These are both owner and renter occupied households. If, however, household formation continued at California rate observed at the beginning of the decade, there would be 696,000 additional households in 2012.
These estimates suggest that pent up demand in California could be large, between 575,000 and 696,000 additional households. And, with owner-occupied comprising on average 58 percent of households, that means between 333,000 and 403,000 fewer owner-occupied homes today.
But, this is not all. We have not taken into account households who are currently renting, but would otherwise choose homeownership. The share of owner-occupied units in California fell by about 2.75 percent from the peak, and the average for the last decade is at 58 percent. While it is difficult to say that homeownership rate should be and what rate it is going to settle at, if it moves from the current 56.2 percent to the average rate (58 percent) in California, there would also be almost 100,000 more home-owners who are currently renters. Lastly, there are those unfortunate homeowners who are currently in a home but would prefer to sell their current home and buy another one. It is difficult to say just how many homeowners are in this situation. Over 30 percent, or over 2 million, of California’s mortgages are under water. Not all of these homeowners would necessarily move, but it is safe to assume that many would. While both of these groups add to the pent-up demand, they are not newly created households and they would add to housing supply as well as housing demand.
All things considered, this analysis illustrates the terminating effect the Great Recession has had on the housing demand. And while the uncertainty over foreclosure crisis and economic improvement still lingers, the size of pent-up demand implies that recovery of the housing market could quickly follow any economic recovery.
Click On Image for larger View
For questions, please contact the Research & Economics Department at firstname.lastname@example.org or (213) 739-8352.