Key demographic trends and their effect on the wood products industry Part II
Focus on household formations for 25-44 age group
Last month, we began a series of Spotlights to address some significant demographic trends. In Part I, we examined the reasons behind declining labor force participation rates (LFPR), especially for younger men under the age of 25. We also focused on the composition of labor force and reasons the LFPR may not recover much. Until the detailed analysis done by the Brookings Report was released, many economists had believed the LFPR decline was mostly temporary and would rebound as the job market improved. For a variety of reasons, it now looks as if the LFPR will remain lower for this cohort as it ages.
In this Spotlight, I will focus on how the declining trend in LFPR appears to be related to the decline in the propensity of younger adults to form households. That decline, plus a reduction in the potential population growth for the 25-44 age group due to a potential cut in legal immigration, could deal a double-whammy to household formations (HHF) for the 25-44 age group.
First, just to refresh your memory, a Base Case outlook for HHF is shown in TABLE 1 using the 2014 Census Population forecast. Prior to the Great Recession, HHF growth was expected to average 1.2-1.4 million per year over the next 15 years. This combined with the need to build housing units to replace demolished units, plus the demand for second homes, supported the view that “trend” housing starts would be near or above 1.5 million per year.
But the recession has forced us to relook at some of the key assumptions. HHF fell far below the “trend” rate over the last 10 years. Even so, the rebound in employment was expected to stabilize the propensity to form households. Thus, HHF growth was expected to rebound in 2016-25.
A closer examination of Table 1 reveals the two age groups will fuel the rebound in HHF growth because of the two population waves. The first and the one that gets a lot of press attention has been the “Baby Boom.” The babies born from 1947 to 1960 are now driving the surge in the over 65 population. The next population wave will be in the 25-44 age group. Historically this is when younger adults get married, have children and buy houses. As a result, growth in this group is very important, not only to the level of housing demand, but the type of units demanded. The growth in these two age groups is partially offset by the decline in the HHF for the 45-64 group. This decline is due to the drop in the birthrate after the baby boom. HHF for the under 25 age group is near zero because of the group’s very low headship rates (below .15) and very little net population growth.
Quick reminder: The forecast for household formations (HHF) for each age group is based on the population growth for that group multiplied by the propensity for the age group to form a household (headship rate). The headship rate history is derived by dividing the number of households by the population in each group. A headship rate of 0.5 means there is one household for every two adults.
Our Base Case has assumed that the headship rates would stabilize near 2015 levels. Since the headship rates for older aged groups have not declined much, the starting assumption still seems reasonable. But as we discuss below, that forecast might be too optimistic for the 25-44 age groups.
Plausible HHF scenario for the 25-44 age group
The headship rate for the 25-34 age group was assumed to stabilize near 0.43, while the headship rate for the 35-44 age group would stabilize near 0.49. Given a population growth of about 9 million adults for the 25-44 age group over the 10-year period, HHF would be expected to increase in the 350,000-400,000/year rate over the next decade. This group would account for about a third of net household growth.
Assuming the headship rate would stabilize or even rebound with the improving job market seemed reasonable. But, as discussed in Part I, the large decline in the LFPR for the under 25 age groups is to likely to drive the LFPR for the over age group lower based on how a starting point for a cohort tends to persist as it ages. Thus, despite an improving economy, the LFPR could still decline further for the 25-44 age groups.
So, let’s look at the two key assumptions underlying the Base Case Outlook. First, let’s focus on the headship rate assumption. Then we will return to the population growth assumption given the likely reduction in immigration.
The headship rate for these two age groups fell dramatically between 2005 and 2016 as seen in GRAPHS 1 and 2. The headship rate for these age groups was either rising or stable in the 2000-2006 period. The dramatic decline in the headship rates after 2006 for these age groups was a primary reason that net household formations fell in the 2006-15 period.
If the headship rates for these age groups had held steady at the 2006 level, then household formation for 2006-16 would have averaged about 270,000 per year higher than what actually happened. For instance, the annual HHF growth in the 2011-15 would have been 1.2 million per year if the headship rate had been stable. In light of what has been happening with the LFPR, it now seems likely that the headship rates might keep declining. We are not about to launch a major research project into the complex social issues that could be involved in what drives HHF by age group. Nor are we going to model the relationship between LFPR and the headship rate. However, there is a high correlation. The LFPR for the 20-24 age group fell about 5% from 2006-15. The headship rates were also falling for the 25-34 age group as well. Common sense suggests that if you are not working, it is unlikely you will form a household. In fact, you might continue to live with your parents as shown in GRAPH 3.
Based on the Brookings Study, we also know that the decline in LFPR is associated with disability levels and dependence on pain killers. So once these younger adults are out of the labor force and find ways to survive without working, many of them may never re-enter the labor force again.
Even so, we have to factor in that some of the decline could be temporary. Many of the jobs being created need more skills than some of the young adults have. That is why some are going back to college or staying in school longer with the hope of finding a better job later.
So, what we are suggesting for planning purposes is a plausible scenario where the headship rate declines further along with the declining LFPR. Assuming the headship rate falls about 0.02 over the next ten years, then HHF for this age group would now be closer to 200,000 per year. This would be about half the growth in the Base Case.
A modest decline in the headship rate (as shown in GRAPH 4) will dramatically reduce the expected HHF rates. So rather than a getting back to the 1.2-1.3 million per year rate, HHF would be more like 1.0-1.15 million per year, or about 10% lower.
Now, let’s address the other key assumption: population growth. The population growth for the 25-44 age group is particularly sensitive to the immigration assumptions. In the 2014 Census population forecast, immigration was expected to average about 1.1 million per year, or about 5.3 million in the five-year period. About half of immigrants fall into the 25-44 age group. So, if immigration were to be cut by 50% by the Republicans, then instead of the forecast population growth of about 9 million over the next decade for this age group, it would be only 4 million.
By including a 50% cut in immigration levels over the next decade, it is possible that HHF growth for this key demographic group would fall to below 100,000 per year. If so, overall HHF could fall below 1 million/year.
In the next Spotlight (Part III), we will look at the implications of this lower growth in young households on the level and type of housing units demanded over the next 10-15 years. We will also look at the marriage rate for this demographic group and the relationship to ownership rates.
Bottom line: We remain optimistic that the improving job market will boost the ability of the 25-44 age group to form households over the next 10 years. Our intent will be to follow this demographic group closely and revise our Base Case outlook accordingly. This low plausible scenario is meant to help companies that need to consider some alternative scenarios in their strategic planning. The low plausible scenario is not the worst case, since deportation of illegal immigrants and another recession could lead to an even lower HHF rate. The case merely makes it very plausible that housing starts could average less than 1.5 million over the next decade as a result of factors driving for the 25-44 age group.