Real Estate Finance in California

Chapter 1

THE REAL ESTATE FINANCIAL ENVIRONMENT

INTRODUCTION

The process of financing real estate transactions involves many variables. It does not take place in a vacuum. Many factors interact together. These conditions comprise the real estate financial environment.

The reader should keep in mind that this environment is not static. A shift in one of the variables of real estate finance will cause the environment to undergo a subsequent change.

HISTORY OF REAL ESTATE FINANCING

Real estate financing has been around for many years. However, its early formation was very unfavorable for the borrower. Prior to the Great Depression, the borrower traditionally only obtained a loan for an approximate period of five years. Interest payments were made periodically. The entire principal amount was due in a lump sum at the end of the loan period. Even in a good economy, this system presents problems for the borrower.

With the advent of the disastrous economic crisis of 1929, borrowers could no longer meet these extreme loan conditions. Mass foreclosures resulted. As is always the case, neither party benefited from this situation. The borrower had no home in which to live in. The lender, on the other hand, was stuck with property that was of little value. Property values became depressed. In addition, consumers could no longer afford to purchase property because of the mass unemployment.

The Federal Government instituted many programs to counteract this big problem. Of major significance was the formation of the Federal Housing Administration (FHA). Under it, fixed-rate loans were made for periods up to 40 years in duration. Principal and interest payments were paid monthly with no balloon payment.

To counteract the unprecedented withdrawal of funds that accompanied the start of the Depression, the Federal Deposit Insurance Corporation (FDIC) and the Federal Savings and Loan Insurance Corporation (FSLIC) were created. They provided stability for the financial institutions by insuring the funds of individual depositors. This sense of security helped restore the depositors’ confidence in the institutions. With this renewed confidence, the financial environment stabilized. Consumers could afford to borrow the capital to buy property. As a result, housing construction increased.

After World War II, the demand for housing became phenomenal. The economy was very conducive to expansion. Several credit crunches appeared from time to time. However, the market always seemed to recover. Growth in housing construction continued. Finally, in the 1970s, the credit crunch became very severe. Depositors were withdrawing their funds from regular savings accounts earning low interest and reinvesting their capital in high-yield investments. This practice is known as disintermediation. In an effort to keep the investors’ capital, institutions were forced to offer higher interest rates on their savings accounts. At the same time, borrowers were still paying the same low, fixed rate that was assured to them years before. The institutions were losing money. Many of them went out of business. Those that managed to survive encountered a lack of working capital with which to loan.

In an effort to remain viable and profitable in an ever-changing economy, several changes occurred in the policies and procedures of lenders. Many different types of loan packages were developed that could be altered to accommodate changes in the market. These packages, which will be detailed later, include such innovations as the variable rate loan and the graduated payment plan. Also, the nature of the loan instruments has been changed. This will also be examined later.

THE CREDIT SYSTEM

The concept of credit is a critical element in real estate finance. Financial lenders forward capital to borrowers that allow them to buy property. The lenders extend this credit even though the borrower cannot presently afford to pay the entire obligation. Their inherent risks are rewarded with the payment of interest by the borrower. To lower their risk, collateral is used as loan security pledged by the borrower.

With this system, a seller forwards products or services to a party who does not have the capital to afford the entire amount at that time. The seller relies upon the promise of the buyer to repay the debt in the future. Often, the buyer must show the ability to pay the debt with his or her employment record. In addition, a buyer normally must demonstrate a propensity for paying credit obligations with a favorable credit history. This is documented with computer systems such as the TRW service.

The use of credit has increased tremendously over the years. Total outstanding credit for 1960 was $779.9 billion dollars. By 1981, this figure had risen to $5,127.7 billion. In the category of total residential mortgage loans, credit was utilized in the amount of $162.7 billion. By 1981, this figure had risen to $1,000.1 billion.

Obviously, not every purchase made in the United States uses credit. Other possible forms of symbolic money used in this country include coins, paper currency, and demand deposits. Coins comprise approximately two percent of our total money supply. Our system of coins includes the penny, nickel, dime, quarter, half-dollar, silver dollar, and Susan B. Anthony dollar. The final type of coin was only issued for a very short time. It was discontinued because it was easily confused with a quarter.

Approximately 20 percent of our total money supply is comprised of paper money. Paper bills are essentially promissory notes that are issued by the Federal Reserve. Contrary to popular opinion, our paper money is not backed by gold. The United States went off the gold standard in 1933. While each paper dollar is backed with a small portion of gold, its main protection is the confidence of the American people. Without it, the dollar would fall dramatically and not be universally honored.

The final category of symbolic money used is demand deposits. These are negotiable instruments drawn against checking accounts. They are commonly called checks. Demand deposits constitute approximately 78 percent of our total money supply. They play an integral role in our current society. The use of demand deposits should continue to grow as we gravitate toward a coinless and paperless money society.

Before leaving the topic of money systems, a historical perspective of other societies would be helpful. It will illustrate the evolution of money systems. This will aid you in understanding our economy and the concept of real estate financing.

Throughout history, different societies have used different methods of financial exchange. The most basic form is commodity money. It uses items such as animal skins, tobacco and tea. Conversely, symbolic money uses items that have extrinsic value. They do not necessarily have value in and of themselves. However, their value is accepted by all in the society. Examples of symbolic money include shells, precious stones and coins. As indicated previously, the United States employs the symbolic money system.

NATIONAL MORTGAGE MARKET

As with any economic market, the national mortgage market is comprised of supply and demand. Without a supply of mortgage money, there would be no mortgage market. Also, without a demand for mortgage money, there would be no mortgage market.

(I) Mortgage Money Supply

There are many ways that money becomes a part of the mortgage money supply. However, the predominant source is savings of depositors. The depositors are usually only concerned with maximizing their return on their money. To pay this return, the entities which receive these deposits loan the deposited funds out to borrowers. The initial depositors may be unaware that their capital is helping to supply the money for the national mortgage market.

(II) Mortgage Money Demand

Demand is generated from three main sources. They are construction loans, sales financing and refinancing.

Construction loans are necessary to assist the builder in buying the property and constructing the buildings. A major party who utilizes this type of loan is the subdivider. The loan can be made in installments or as a lump sum. The amount of the loan can be based upon a guaranteed price or on a cost-plus-price basis.

Mortgage demand is normally thought of as sales financing. With sales financing, a buyer is loaned a portion of the total purchase price of a piece of property. Licensees will be most familiar with this type of mortgage money demand.

Refinancing is a prevalent source of demand. Refinancing refers to the practice of financing property which was not previously financed or to renew or extend existing financing. It has traditionally been associated with raising needed money by tapping into the equity of a person’s property. With the decline of the fixed-rate mortgage, borrowers are facing the problem of altering mortgage terms in order to not default on payments. This is due to problems such as increased interest charges on adjustable rate mortgages and accelerated payments on graduated payment plans.

The demand for mortgage money has continued to increase over the years. According to the Federal Reserve Board, in 1960, the total amount of outstanding mortgage loans for all properties was $208.9 billion. This included residential, commercial and farm properties. In 1970, the total amount was $473.1 billion. By1980, the total amount skyrocketed to $1,446.1 billion. While some of the increase can be attributed to inflation, it does not provide an adequate reason. A better rationale is that the demand for mortgage money is greater than before.

EXTERNAL FORCES AFFECTING THE MORTGAGE MARKET

The mortgage market does not exist by itself. It functions along with a multitude of other markets and institutions. As a result, many forces are exerted upon it. These forces affect the mortgage market in varying degrees.

International forces have long affected this market. In the past, when international forces fluctuated, the American mortgage market reacted accordingly. This situation has changed markedly. We no longer use fixed exchange rates. With the present floating exchange rates, foreign financial and economic changes have no significant effect.

National forces, on the other hand, do have an appreciable effect on our national mortgage market. There are a myriad of these national forces. Some examples include the inflation rate, consumer demand, money supply, housing supply, strikes by labor unions, and government regulations.

Most of these forces contribute to the nation’s business cycles. Business cycles are the recurrent expansions and contractions which occur in the general business activity.

Business cycles normally range in duration from two to nine years.

When the business cycle is depressed, demand is low and interest rates are low. When the business cycle rises, demand increases and interest rates increase. Business cycles are an important ingredient to the economic law of supply and demand. There are many explanations for the fluctuations in business cycles. Some contend that the business cycles are affected by psychological influences on the part of the American public. Some believe that the business cycles are affected by monetary influences such as changes in interest rates and credit conditions. Still others believe that the business cycles are affected by economic-demographic influences such as population shifts, spending and savings.

Local forces also affect the mortgage market. Economic conditions can greatly vary from one city to another. Also, city ordinances can affect housing construction. All of these factors can have an effect on the market.

Finally, lending institutions have a tremendous influence on the mortgage market. Their policies can help stimulate or depress the market. While they are regulated by the government, they do have a certain amount of freedom. An important area is in the setting of interest rates on savings accounts. As a general rule, to break even, financial institutions must charge at least one to two percent more in interest on loans than what they pay as interest on savings accounts. Since institutions are constantly trying to lure depositors with higher interest rates, they must compensate by charging higher interest rates on mortgage loans.

MAJOR PROBLEMS OF REAL ESTATE FINANCING

The real estate financial mechanism faces many difficulties. Lenders must contend with the lack of available lending funds. Without them, they cannot effectively function. The borrowers must try to find loan money that is affordable. They cannot rely on refinancing as a viable means of dealing with unfavorable loan terms. Borrowers must also deal with the fact that property values continue to escalate with spiraling inflation and interest rates. As a result, potential homeowners cannot afford to buy a house. All of these problems must be dealt with. If these difficulties go unchecked, real estate financing will suffer.

MANAGEMENT OF THE ECONOMY

The mortgage market exists within the confines of the U.S. economy. It is important to understand how the government manages our economy. Their efforts directly influence the real estate market.

Economy management is accomplished through fiscal and monetary policies. Hopefully, the two policy postures will complement each other.

(I) The United States Treasury

This government department determines our nation’s fiscal policies. They are responsible for managing the daily operations of the Federal Government. This includes such activities as collecting the operating revenue of the government and controlling the federal debt.

The United States Treasury collects money from the federal income tax, the social security tax, and other revenue sources. These funds are deposited in appropriate banks.

The control of the federal debt is one of their most important responsibilities. A debt occurs when government spending exceeds received revenue. To date, the federal debt is in the hundreds of billions of dollars.

When the Federal Government must pay a debt and doesn’t have the available funds, they often issue securities. Securities are short-term or long-term debt instruments which are sold to the American populace. They raise funds for the government. Long-term securities are called Treasury certificates. They are issued for terms ranging from five to ten years. Intermediate-term securities are called Treasury notes. They are issued for terms ranging from one to five years. Short-term securities are called Treasury bills". They are issued for terms under one year.

(II) The Federal Reserve System

They determine our nation’s monetary policies. This is accomplished by regulating credit conditions and assisting the economy to reach a level that is conducive with stable prices, high employment, and economic growth.

The Federal Reserve has many tools which they can utilize. They include issuing Federal Reserve Notes, regulating and assisting member banks, enacting credit controls over segments of our society, determining discount rates, and open market operations. As a note of clarification, open market operations involve the purchase or sale of government securities in lots. The securities may be issued by the Federal Housing Administration, the Government National Mortgage Association, and many other possible sources.

MORTGAGE LENDERS

Many different variables and elements concerning the mortgage market have already been discussed. A primary party in this market is the mortgage lender. The specific characteristics of these intermediaries will be discussed in subsequent chapters. However, their role in the real estate financial environment should be mentioned in this chapter.

As a collective whole, they have a tremendous amount of financial resources. In 1960, the amount totaled $597.4 billion. In 1970, the figure had risen to $1,339.0 billion. By 1981, the figure had climbed to $4,246.0 billion. A very substantial portion of their assets are dedicated to making real estate loans. Because of these realities, the role of financial intermediaries is of great significance in the mortgage market. Without their participation, there would be no market.

REVIEW

To fully understand real estate finance, it is important to analyze the mortgage lending market environment. This includes such components as methods of financial exchange, the mortgage system, and external forces acting upon the market. There are many economic influences which affect the mortgage lending market. The principles of supply and demand play critical roles. They help dictate available funds and predominant interest rates. The capital of financial intermediaries has increased substantially over the years. They heavily invest these funds in the mortgage market.

UNDER ALL IS THE LAND

Now that we’ve begun to see just how real estate lending activities fit into the overall economic picture, and how significant it is in terms of the overall economy, let’s break that significance down a bit further. A good place to start would be the preamble to the Code of Ethics of the National Association of Realtors:

PREAMBLE

Under all is the land. Upon its wise utilization and widely allocated ownership depend the survival and growth of free institutions and of our civilization. The REALTOR® * should recognize that the interests of the nation and its citizens require the highest and best use of the land and the widest distribution of land ownership. They require the creation of adequate housing, the building of functioning cities, the development of productive industries and farms, and the preservation of a healthful environment.

Such interests impose obligations beyond those of ordinary commerce. They impose grave social responsibilities and patriotic duty to which the REALTOR® should dedicate himself, and for which he should be diligent in preparing himself. The REALTOR®, therefore, is zealous to maintain and improve the standards of his calling and shares with his fellow REALTORS® a common responsibility for its integrity and honor.

THE ECONOMIC MEANING OF REAL ESTATE

Democratic sentiments and principles are clearly reflected in this document, as are the underlying market assumptions of a free economy, such as private ownership of property and a wide distribution of ownership. These and other aspects of our economy will be discussed in greater detail in following chapters. For now, it is enough to recognize that real estate, under our system of economic and political organization, is regarded as a necessary element in the growth of free institutions and of our civilization and a requirement for the creation of housing, cities, industries, farms, and the preservation of a healthful environment. The significance of the real estate industry in the over-all picture begins to emerge.

REAL ESTATE AS A MARKET

It is very important that you begin to think of real estate as a market, for this is a key concept in economics and finance. Real estate itself is a commodity, and is considered one of the four factors of production: land, labor, capital, and entrepreneurship. As a commodity, real estate is bought and sold in a market. It is actually more accurate to say that there are a number of real estate markets.

There really is no one monolithic real estate market; instead, there are different types of properties which comprise markets of their own. For convenience sake we often refer to the real estate market, and it will be seen that indeed all markets within the real estate market respond similarly to over-all market forces.

There are five broad categories of properties, each of which may be considered a separate market within the larger real estate market. We will take a moment here to consider the characteristics of the various types of real estate properties, what distinguishes them from one another, and what they share in common. The categories are:

1. Residential properties

2. Commercial properties

3. Industrial properties

4. Farm properties

5. Special purpose properties

THE RESIDENTIAL PROPERTY SUB-MARKET

Within cities, residential properties make up the largest land use category. In fact, nearly half of all land in major urban areas is used for residential purposes. Of this large residential market, there are two basic types: sales markets and rental markets.

It is convenient to think of rental properties as those which are not designed to be occupied by the owner of the property. These are broken down into such structures as multi-story apartment buildings, duplexes and four-plexes, and clusters of townhouses, as well as garden-style buildings and two story walkups. There are generally fewer square feet of living space in rental units than in other types of owner-occupied living units, and it may be said that the people who live in rental housing are to a significant extent from the younger and older ends of the population spectrum.

The structures which make up the sales market are structures which are built with the expectation that someone will buy them and live in them. The structure which perhaps typifies the sales market is the single family housing unit. Other types of structures in the real estate sales market include condominiums and cooperatives, as well as mobile homes.

There is a wide range in the proportion of the rental market to the sales market, depending upon a variety of conditions from one community to another. For example, a community which contains a large university or a military base is likely to contain a higher proportion of rental housing, simply because of the transient nature of students and military personnel.

*The term "REALTOR® " is a registered trademark of the National Association of Realtors.

THE COMMERCIAL PROPERTY SUB-MARKET

Here we have a market, the demand for which is derived. That is to say, the demand for commercial property has nothing to do with the value of the property itself. We will discuss the concept of demand (and supply) in later chapters, but it is interesting to note here this characteristic of the commercial real estate market.

For example, something as seemingly unrelated to real estate as consumer appetites and habits can provide a demand or lack of demand for commercial properties. If, for example, the nation’s consumers suddenly decided it was unhealthy to eat candy, then there would be a lessening demand for commercial space for sweet shops; rental space for sweet shops would then eventually diminish. This is what is meant by derived demand; the demand for commercial space is derived from something other than its intrinsic property value.

Commercial properties primarily consist of properties which are utilized for business operations: the sale of goods and services. This would include individual shops and offices, as well as shopping centers of various types and office buildings. Office buildings are generally separated from retail properties by the distinction that they house service and information businesses, whereas retail businesses (the sale of goods) generally operate in shopping centers and individual stores.

The proportion of commercial land use in most major urban areas is somewhere around 15 percent. The central business district, of course, would have a much higher percentage of commercial property. The value of commercial property, as suggested by the fact that its value is derivative, is closely linked to how well the property contributes to the occupant’s profits. Among commercial real estate properties, a distinction is frequently made between those which are general and those which are specific in terms of use. In other words, commercial real estate which can be easily converted from one use to another (general commercial real estate) is more highly valued than property which is designed and built for a specific type of business enterprise.

THE INDUSTRIAL PROPERTY SUB-MARKET

This is a very specialized market, and each type of industry within this market actually creates its own sub-market. In the average major urban area, industrial properties comprise perhaps five to ten percent of the land use.

The terms light and heavy are frequently used to separate industrial property into two convenient categories. This of course refers to light and heavy manufacturing, as the industrial market customer is exclusively a manufacturer of goods, as opposed to the retail seller of goods and the seller of services and information who use commercial properties.

Perhaps the most significant attribute of industrial property is that its occupants can have a major effect on a city’s economy by providing employment, income, and tax revenues. Thus, many community governments will offer a variety of incentives to industrial tenants to locate in their area.

THE FARM PROPERTY SUB-MARKET

Here, of course, we step out of the city and into the country. Well, not entirely. You will often find urban borderland being used for agricultural production, and often it is used simultaneously for speculative purposes. In these situations the owner of the property may derive some agricultural income from the property while holding it with a view toward its appreciation as the city grows in his or her direction.

The national view of farm properties finds them being used primarily for raising crops and timber, as well as for pasture. Many areas of the country will only support a particular kind of crop, e.g. citrus in Florida and California, cotton in the south, etc.

THE SPECIAL PURPOSE PROPERTY SUB-MARKET

Here we are talking about theaters, cemeteries, churches, parks, government properties and some types of noneconomic properties, such as historical sites. Compared to other types of properties, these comprise a very small proportion of total land use, probably less than one percent.

COMMON DENOMINATORS

Now that we have seen that the real estate market is really comprised of many sub-markets, depending upon land use, we should mention the various ways in which all real estate markets are similar. There are five factors which are special to the real estate industry and which unite all the various markets. They are: fixity of location, relatively long economic life, relatively large requirements for capital investment, an interdependence of decisions and the nature of ownership rights, and the concept of illiquidity.

What, you may wonder, does the fixity or immobility of real estate have to do with economics? The implications are very important. Think in terms of value and what the value of real estate depends upon. The most vivid example of the effects of immobility upon the value of real estate is a familiar one to anyone in the real estate business: shifts in transportation patterns.

What happens, for example, when a new freeway bypass is built, re-routing traffic patterns away from established businesses? Obviously, since these businesses cannot move their properties (fixity of location), many of them will suffer economic distress, if not outright disaster.

In addition to changing traffic patterns, fixity of location can cause real estate properties to fall victim to shifting population patterns or a decline in the general quality of the area in which they are located. The owner of a neighborhood shopping center in a deteriorating area or an area in which the crime rate has risen sharply may be ruined simply because of the fixed nature of the real estate property. The fixed nature of real estate property is exacerbated by the fact that most tenants are local. That is, few are absentee owners. This is true not only of commercial properties, but of residential properties as well. Homeowners with second homes number only some five to six percent of all homeowners.

In other words, demand, an economic concept we will be discussing in considerable detail, is created, in the real estate market, largely by local residents, and local residents are more likely than absentee owners to be aware of, fall prey to, and purchase with a view toward the fixity of location of real estate properties.

ECONOMIC LIFE

Compared to other types of commodities, real estate has a long life, which is what we mean by a relatively long economic life. Unimproved land, for most practical purposes, has an economic life without end. Improvements on land don’t last forever, but they are generally meaningful in an economic sense for several decades.

What, then, are the implications of long economic life? Here the words supply and demand once more arise. Real estate investments, in land and improvements both, arise out of demand. Demand, it should be pointed out, is something which fluctuates and changes, and these fluctuations and changes in demand take place in the short-term. That is, during the relatively long economic life of any given property, there are likely to be a number of changes in demand. This characteristic of real estate, long economic life (combined with short-run declines in demand) has a number of serious implications. First of all, it is obvious that real estate investors would be wise to carefully examine their markets and the general environment of a given property before making the investment.

Secondly, investment in real estate (a long term investment) must of necessity be an investment in the future. Therefore, since the benefits of a property are spread out over a large number of future years, it is obvious that the present value of a property is really a projection of future benefits.

This aspect of real estate investment (long economic life, present value based on future benefits) combines with real estate financing to force investors (including homeowners) to make decisions based on long term considerations. Most real estate is financed by debt, and families who purchase homes not only commit their present savings to the purchase, but their future savings as well. Lenders will necessarily be concerned with the long term market conditions relating to any property they finance, since the property itself is security for the loan.

OUTLAY

Real estate is not only conspicuous by being fixed in its location and long-lived, but also by the relatively large outlay of capital required to purchase it. It has always been true, and remains true today, that the purchase of a home is the largest single investment an individual is likely to make in his or her lifetime. In the mid-eighties, the cost of an average single-family home (nationwide) is over $60,000, a sizable figure for most people.

Here we touch on the national economy in a truly significant way. Private savings are extremely important to the national economy. Here we will mention in passing how savings and the relatively high capital outlay required for real estate purchases combine to create a powerful effect on the economy.

In the housing industry alone, individual homeowners commit a huge portion of present and future savings to the purchase of their homes. With this major portion of savings invested in home ownership, the welfare of the economy is significantly affected by the ways in which housing prices change.

Imagine, for instance, what would happen if housing prices were to decline by as much as forty percent. First of all, since a lot of individual wealth is held in real estate, much of that wealth would be lost. The repercussions would rebound across the entire economy, and millions of people and businesses would suffer economic distress.

Obviously, in any discussion of the cost of real estate, there is the issue of construction cost. In fact, construction and operating costs for real estate tend to increase faster than income grows, and the result is that there are fewer individual purchasers eligible to enter the market.

As the required capital outlay continues to increase, so the transactions become more complex. The first necessity for most real estate purchases is borrowing a portion of the purchase price. This in turn necessitates an accurate determination of market value and a precise description of property rights for all parties involved in the transaction. Furthermore, as the size of the capital outlay increases, so ownership arrangements become increasingly complex.

INTERDEPENDENCE

What you do with your property will have some effect on the property of your neighbor. This is a truth concerning real estate which has long been recognized, and which in modern times has given rise to strict community controls over land use. Generally speaking, the denser the population of an urban area, the more stringent the land use controls (building codes and zoning regulations).

Land differs from most other commodities in this respect. You are more or less free to do what you will with any other commodity you happen to own, but your freedom with regard to real estate, because of the interdependence of real estate, is relatively limited. This characteristic of real estate brings into play such issues as police power, governmental regulation, and environmental considerations. Obviously, zoning ordinances are a primary consideration in any real estate investment.

ILLIQUIDITY

In this, real estate is not alone. However, the degree of illiquidity of real estate is higher than in other types of investments. You can liquidate savings accounts, stocks and bonds, and commodities in short order. On the other hand, it may take you several months to sell your private residence, and private residential properties are probably easier to sell than other types of property.

Not only that, but it is usually necessary to involve a number of people in the sale of a property, particularly commercial property, where the participants could include attorneys, lenders, brokers, appraisers, accountants, and marketing professionals. It might take several years to sell certain commercial properties.

DEMAND AND DEMOGRAPHICS

For individuals and society as a whole, demand for real estate is a function of three very important considerations: want, willingness, and ability. A buyer must want something, must be willing to pay to satisfy the want, and must have the ability to pay.

How, you ask, do demographics relate to this demand which is created by wants, willingness and ability to pay? Well, there are certain social factors which have a bearing on real estate markets, and these are reflected in demographics. Demographics can provide a reliable picture of the general atmosphere and environment in which real estate professionals make decisions about current trends and future forecasts with regard to consumer wants, willingness, and ability to enter the market.

We will briefly touch on some of the more important demographic considerations here, and we will take them up in more detail in a later chapter. Some of the more important demographics are: population growth or decline, household formations, age distribution, migration, standard of living, and desire for home ownership.

POPULATION GROWTH AND DECLINE

This is the basis for all demand in the real estate market. Furthermore, the rate at which a population is increasing determines future demand. Obviously, it becomes very important to understand the impact of population on demand and to learn how to make a reliable determination about population growth in your market.

Population is basically determined by net immigrations, birth rates, and mortality rates. The U.S. Bureau of Census provides a source book called the Statistical Abstract of the United States which contains a wide variety of important statistical information, not the least of which is population information, including future projections.

As an example of how this information can be useful to you, the Statistical Abstract provides future projections of population growth based on certain assumptions about mortality rates, birth rates, and net immigration, illustrated in various scenarios. Most reasonable projections, barring major unforeseen circumstances, strongly suggest a rate of population growth in the U.S. sufficient to have a tremendous impact on our quality of life and large enough to require, even in the most conservative scenarios, a very substantial commitment of resources and planning in the real estate sector.

THE FORMATION OF HOUSEHOLDS

The Bureau of Census says that a household:

. . . comprises all persons who occupy a housing unit, that is, a house, an apartment or other group of rooms, or a room that constitutes separate living quarters. A household includes the related family members and all the unrelated persons, if any, such as lodgers, foster children, wards, or employees who share the housing unit. A person living alone or a group of unrelated persons sharing the same housing unit as partners is also counted as a household. Group quarters are living arrangements for persons who do not live in housing units. Examples of group quarters are: a rooming house, an institution, a college dormitory or a military barracks.

The Census Bureau further says that a family:

. . . refers to a group of two or more persons related by blood, marriage, or adoption and residing together in a household. A primary family consists of the head of a household and all other persons in the household related to the head. A secondary family comprises two or more persons such as guests, lodgers, or resident employees and their relatives, living in a household and related to each other but not to the household head.

We are here more concerned with household formations than family formations. You should think of family formations as a sub-category of household formations. Housing units are needed for every household formation, not merely every family formation. Using Bureau of Census figures on total households and average household size, you can compute future housing unit needs easily.

For example, if the average household size is four, and there is a projected increase in population over a given period of time of some 100,000 people, then simply dividing 100,000 by four will tell you that we are going to require 25,000 new housing units. It is interesting to note that under the same projected population growth, if the household size is only 2.5, then the need for housing units jumps to 40,000. Hence, the smaller the household size, the greater the number of total housing units needed.

These are forces which apply pressure to the housing industry and real estate resources (population increases combined with household size decreases); these, in addition