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11-010-XIB
Canadian Economic Observer
October 2005

Feature article

Socio-Demographic Factors in the Current Housing Market

by Derrick Thomas*

Introduction

Like many countries, Canada has recently experienced a surge in housing starts. The number of new homes built annually has doubled since 1995. The boom intensified after 2001, when starts jumped by over 25%. Most new dwellings were single-detached homes, but the boom has affected almost all areas of housing, including apartments and multiples despite a slight rise in rental vacancy rates. The market for owner-occupied units appears hottest, however, and this paper deals primarily with that.

An understanding of the factors underlying the current strength of the housing market is useful in predicting how it could evolve in the future. The economic precursors of the boom, notably low interest rates and easy credit, have been widely and justly acknowledged. This paper looks at socio-demographic factors such as population, migration and household formation whose links to housing are explored less often.

The Life Cycle and Housing

The most direct socio-demographic influence on the demand for housing is the rate of household formation and dissolution. The lifespan of households depends not only on the age at which people form their own households, but also on migration, divorce, aging and how many elderly remain in private households.

The typical household life cycle runs from residing with parents, to renting, to the purchase of a first home, perhaps the purchase of a more expensive home, and ultimately in old age to renting, institutionalization or living with relatives again. Labour force activity and income also change with the life cycle.

Data from the Survey of Household Spending (SHS) demonstrate a clear relationship between home ownership and age.

Figure 1

Holding other factors constant, entering the market for an owner-occupied house declines with age. From 1997 to 2003, the highest probability of buying a first home was among households in their twenties. But couples in their thirties accounted for the largest proportion (40%) of first-time home buyers, because they were more likely to have formed independent households and there were simply more of them. The purchase of a first home often coincides with or precedes the birth of a first child, and increasingly precedes marriage.

The Housing Boom in Context

Spending on residential construction has, broadly speaking, been increasing over the past 3 decades, interrupted by pronounced slumps during recessions in the early 1980s and early 1990s.

Figure 2

There has been a trend toward larger and more expensive homes through renovation and trading up. However, increases in the overall value of the housing stock or even annual spending on real estate do not necessarily rest on housing starts. Housing starts imply a market for dwellings among persons who do not already own their own home. There would appear, in short, to be demographic factors involved. As one might expect, given the trends in births, marriages and population generally, the long-term trend in housing starts has been downward.

Figure 3

Housing the boomer generation beginning in the late 1960s involved a larger surge in construction than the current one, especially relative to the stock of existing housing. In the first half of the 1970s, housing starts added over 3% (and in some years almost 4%) to the housing stock. Growth was interrupted by prohibitively high interest rates and recession in the early 1980s, but resumed with better job prospects and cheaper credit. By 1987, new starts constituted over 2.5% of the stock. By the early 1990s, however, most boomers had been housed (although not exclusively in owner-occupied dwellings).

The ‘baby bust’ cohort born between 1966 and 1980 was much smaller and there followed a slump in construction from which we only recently recovered. As demographers had predicted, housing starts hit historic lows in the 1990s (Foot and Stoffman, 1996). The early children of the boomers however (‘the baby boom echo’) are now entering their twenties, forming their own households and raising demand for housing.

Figure 4

The current expansion in housing starts appears quite modest when viewed in relation to the rapidly rising net total stock. Despite a sizeable increase in absolute terms, starts climbed from a low of under 1% of stock of housing in 1995 to only 1.8% by 2003.

Demographic Trends and Housing

Curiously, the current growth in housing occurred against the backdrop of declining population growth. In particular, the rate of natural increase (births minus deaths over population) has been falling for decades. Moreover, the population is aging, and fewer Canadians are now in their thirties (the baby bust generation). The number of households in this age group declined in absolute terms by over 13% between 1996 and 2001, while households under 30 also declined, at least up until 2001. As a result, fewer households are now at the stage when they are most likely to buy a new home than during the nadir of housing construction in the mid-1990s.

Figure 5

Several factors have maintained the number of households and recently even produced a modest increase in the rate of growth. First, the vanguard of the large baby boom echo generation (born in the 1980s and early 1990s) is now entering their twenties and presumably starting to move out on their own, raising the demand for housing. Although they had not yet formed independent households by the Census of 2001, the number of 18 to 24 year olds grew by 160,000 between 1996 and 2001, and a further 100,000 were added between 2001 and 2003. They now number more than 3 million, or about 1 in 10 Canadians. While birth rates have declined for some time, this generation owes its size to the even larger boomer generation from which its parents are drawn. This large ‘echo’ group led demographers to predict rising demand for rental accommodation in this period (Foot and Stoffman, 2000). The growing number entering their twenties helps to sustain the rental market and ensure that buying remains an attractive alternative. The SHS data also suggest that there are more home buyers in this age group.

Secondly, the population may be aging but people are also living longer and remaining in their homes longer (Cranswick and Thomas, 2005). Aging implies less home buying, but it also implies ownership and the occupation of the existing stock by older couples and widowed singles. Along with the falling birth rate, this contributes to the long-term decline in average household size (from 3.9 in 1961 to 2.6 by 2001). For a variety of reasons, including later marriage and more divorce, more young people are also in single person households. In short, Canadians have been spreading themselves over more housing units.

Thirdly, the housing market is tied to migration, both within Canada and from abroad. People moving to a new area need housing. Some will rent and others will buy. For more than a decade, immigration from abroad has been sustaining the size of our population and the formation of new households. According to the Census, the number of households grew by 7%, or about 734,000, between 1996 and 2001. Almost one-third of this growth was due to an increase in households where the primary maintainer (the person who pays most of the bills) is foreign-born.

Immigrants typically arrive as young adults – some already have families, while others quickly form households – and their impact on the housing market is rapid and direct. In the 2001 Census, for example, over 40% of households that had arrived over the previous five years lived in a home owned by a family member.

Like immigrants, Canadian-born migrants are attracted to large dynamic urban areas. The probability that a household will buy a first home in a given year falls with the size of the city, from 1.3% in cities over one million people to 0.7% in rural areas. Similarly, the probability of purchasing is higher west of Quebec and lowest in the Atlantic region. These differences reflect current migration patterns: Canadians are moving from east to west and from rural to urban areas. As they move, demand for new housing increases in the destination areas, while in the places they leave behind the housing stock may be abandoned or retired. In short, the housing market is highly variable across regions and cities.

Mortgage Rates, Prices and Incomes

While these social and demographic forces have been in action for some time, the trigger for the current housing boom was lower interest rates after the mid-1990s. The most precipitous drop occurred in 2001, when the Bank Rate plunged from around 6% to 2.5%. Mortgage rates followed suit, with the one-year rate falling from 7.7% in 2000 to 4.6% in 2001 and remaining below 5% since.

Based on SHS data, each percentage-point drop in interest rates between 1997 and 2003 spurred about 16,000 additional first-time home buyers. In addition, since 2001 CMHC has twice reduced premiums on the mortgages it insures, and banks have been willing to lend without any down payment by the purchaser.

The lower cost of borrowing, however, did not produce a structural change in the social and demographic characteristics of households owning or purchasing a home. Instead, homebuyers have become a little more diverse along virtually every dimension. It is probable, however, that the changing cost of housing influenced the behaviour not only of existing households, but also led some individuals living in those households to form separate households. Because our survey samples largely reflect the characteristics of households in the last census, these new households might not be identifiable until the 2006 census.

It seems that the changes due to lower interest rates occurred in two stages. When interest rates initially dropped, homeownership became more affordable for a wider spectrum of households. There may have been some pent-up demand among boomers who had not yet been able to buy a home, as well as some buying by younger people just establishing their own homes. For some people forming new households, easier credit may have tipped the scales in favour of buying over renting. As demand picked up, however, house prices increased and the window of opportunity closed for lower income households.

Naturally, home buyers require a certain level of wealth or income. For households that already own a home, the probability of replacing it with a new one is strongly influenced by household income. Among first-time buyers, however, things are different. Beyond a certain threshold, income level has more influence on the size and price of the house purchased than on the probability of buying a first house.

Figure 6

For decades, homeownership has represented a way of building equity and households demonstrate a distinct preference for ownership over renting, even if the first home must be a modest one. In the SHS, for instance, a majority of first-time homebuyers give the desire to become owners as a reason for moving. Households apparently purchase a house as soon as they can afford one. This suggests the existence of a pool of home buyers ready to enter the market should homes become more affordable.

The sharp drop in interest rates in 2001 apparently lured several groups into buying a home. On average, the incomes of home buyers were lower in 2002 than at any point since the mid-1990s. The real median household income of buyers was about $67,570 over the period 1997-2001, but fell to $63,140 in 2002 before rebounding to $70,575 in 2003.

Other indicators point to atypical households entering the market in 2002. More first-time buying occurred in rural areas and more buyers indicated that their new home needed major repairs. Homebuyers were also less often couples, more were single, divorced or separated individuals. These smaller households usually have lower incomes.

House prices were essentially stagnant over the latter half of the 1990s. They began to creep up after 2000 but the largest increases occurred after 2002. According to SHS data, the average price paid by all home buyers increased by over $25,000 (or 15%) between 2002 and 2003 to almost $200,000. But the amounts paid by first-time buyers increased more slowly, at least initially. Meanwhile, household incomes remained relatively stable.

Figure 7

Homes, in short, are no longer more affordable. In constant dollars, the average annual mortgage payment made by home buyers was higher in 2003 than in any previous SHS.

As a result, by 2003 lower income households were less active in the housing market. There was also less purchasing in rural areas than in 2002. Similarly, fewer houses purchased were in need of repair and couples made up a larger portion of the market. However, a few changes persisted. Since 1996, the number of common-law couples buying homes has increased and the age distribution of buyers has been a little wider. While the median age for home buyers was about the same, there were simultaneously more purchasers under 30 and over 40 years old.

Still, low interest rates continue to attract home buyers, as real estate remains attractive relative to other investments. Persons with income or wealth might be inclined to invest more in a home for themselves or even for their children. Any capital gain on the sale of a principal residence is tax free. Perhaps this accounts for the lack of a discernable trend in the propensity of Canadians to purchase or own a second or vacation home.

Even if interest rates were to rise, some forces would tend to maintain stability. Among them are the demographic realities discussed above. A residence differs from other investments in that the investor lives in the dwelling and requires a place to live in any case. Paradoxically, the market segment perhaps most sensitive to interest rates would be more expensive dwellings, as owners seek liquidity in order to pursue other opportunities. They might buy less expensive homes. Lower income households might, on the other hand, be inclined to hang onto their homes rather than rent.

Summary

The relationships between socio-demographic change and housing are complex. At their nexus, however, is household formation and dissolution. The rate at which people set up new households in Canada affects demand for many goods, but economic conditions and prices can also influence the behaviour of individuals to form or break a household. The cost of housing is obviously important in this regard.

There are clearly social and demographic forces including the maturation of the baby-boom-echo, declining household size and immigration, that would predict a modest increase in the number of new households and thus the demand for housing over the first half-decade of the new millennium. It is certain, however, that the impact on housing has been amplified by declining interest rates.

While homebuyers have more diverse social and demographic characteristics than in the past, the probability of purchasing a first home is still highest for young couples and the probability of trading up is higher for older higher-income families. For first-time buyers, a certain minimum income is essential, but beyond this threshold the probability of purchasing does not increase.

Thus, over certain ranges, first-time buyers may be particularly sensitive to changes in the cost of buying and financing a home. Young couples may make decisions around household formation, marriage and even childbearing according to the cost of housing. These decisions have social and demographic implications that in turn feed back into the economy.

Bibliography

Foot, David K. & Daniel Stoffman. Boom, Bust & Echo 2000. Toronto: Macfarlane Walter & Ross. 1998.

CMHC. ‘Housing the Boom, Bust and Echo Generations’. Research Highlights, socio-economic. Issue 77. March 2002.

Royal Lepage. First-Time Homebuyers Report 2004. www.royallepage.ca.

Kelly Cranswick & Derrick Thomas. ‘Elder care and the complexities of social Networks’ Canadian Social Trends. Statistics Canada. Summer 2005

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Note

* Analysis, Social and Demographic Statistics, (613) 951-2093.


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