How will Gen Y’s future income expectations impact future home prices?

Lower incomes for Gen-Y

Myth: home prices will always increase.

Fact: home prices are dependent on the amounts homebuyers are qualified to pay.

Presumably then, home prices will fall flat or even decrease as the amounts homebuyers are qualified to pay levels or falls. So what affects the amount of mortgage monies homebuyers are qualified to borrow?  (Hint: the operative word is “qualified”).

This is known as buyer purchasing power, primarily consisting of:

  • annual incomes;
  • personal savings; and
  • mortgage interest rates.

Lucky for California’s housing market, annual incomes always go up, right?

Wrong. In fact, per capita income actually decreased a lot after the 2008 recession and nominal dollar income has only caught up in California five years later. Further, the annual pay increases that workers expect as they advance in the workforce are shrinking as the years go by, a long-term trend of income inequality.

College graduates born between 1921 and 1930 earned 3.5 times more after 30 years in the workforce, facts from a study by the St. Louis Federal Reserve. Graduates born in the next decade (1931-1940) earned 2.7 times more over the next 30 years. And those born in 1941-1950 earned only 2.4 times more over the next 30 years.

Related articles:

Federal Reserve Bank of St. Louis: What Flattened the Earnings Profile of Recent College Graduates?

The distribution of California’s human resources

Flash forward to 2013. Today’s generation trying their best to enter the workforce (Generation Y, or Gen-Y) often take low-paying jobs to get their foot in the door. But these low-paying jobs are unlikely to produce the same long-term payoff for their level of education that it did for, say, their parents’ generation.

The reasons for this slowdown in earnings increases are many, due primarily to the fact a greater percentage of the population (33.5% in 2012) have college degrees today than at any other time in U.S. history. In California, 30.3% of the population had a bachelor’s degree or higher as of 2011, according to the U.S. Census. As the supply of college graduates increases, the amount employers are willing to pay becomes increasingly less competitive.

Further, during the 2008 recession when unemployment leapt, wages remained roughly level across all job sectors. This is uncharacteristic, as increased unemployment usually puts downward pressure on wages (and vice-versa). Today, as unemployment slowly drops in California, wages are barely creeping along with the rate of inflation, sometimes falling below inflation rates.

The recession’s pent-up wage cuts will slow income growth for the next several years. This phenomenon was demonstrated in the aftermaths of each of the U.S. recessions experienced since 1986. However, the magnitude of the 2008 recession has prolonged the stagnant income growth, which will likely continue even after the recovery is complete.

Related articles:

The New York Times: Data Reveal a Rise in College Degrees Among Americans

San Francisco Federal Reserve Bank: The Path of Wage Growth and Unemployment

Lower income: less saving

The second qualifying factor in the amount a homebuyer can pay is determined by the amount of their down payment. Unless our imaginary typical homebuyer has a rich benefactor, this down payment relies on their savings.

No good news for the housing market: average personal savings have declined nationwide to 2.6% in Q1 2013. For comparison, the savings rate peaked at over 12% following more than two decades of rising interest rates (of note: when savings rates peaked in the 1980s, the interest rate on savings was two-three times greater than what it is today). This means that on average, today’s potential homebuyers  save less than a quarter of what their parent’s saved.

Related article:

The 20% solution: personal savings and homeownership

This low savings rate is compounded by decreasing income gains. This is, of course, if they have a job at all.

Gen Y has had the misfortune of entering the job market following the 2008 recession. For most, this has meant either:

  • putting off employment (seeking asylum in graduate school where they take on student debt or hangout in their parents’ basements); or
  • succumbing to underemployment.

Both of these realities will cause Gen Y to delay the purchase of a home for several years, say around ten years, past the expected first-time homebuyer age of 25-34 years. As the average age of first-time homebuyers increases, expect California’s homeownership rate to continue to slip away. Homeownership will suffer until Gen Y finally gains enough income and savings to make their foray into homeownership, likely around 2018-2020.

Related article:

Will first-time homebuyers save California’s homeownership rate?

Today’s prices, tomorrow’s downfall

The word of the moment is that home prices are up, optimism is high and prices will continue their trend upward. However, by taking future incomes and savings into account, we now know the long-term picture for sales volume, and thus prices, is somewhat less rosy than the moment’s trend.

The price gains made over the past 12 months have been supported solely by the recent fever of speculator activity. Speculators are flighty creatures, who enter the market for a quick profit. They leave at the first sign of faltering prices and lack of ability to flip at a profit. And they will falter. Why?

The support needed from end users (those buyer-occupants and buy-to-let investors) is simply not there. All the cash is in the hands of investors, and it has not (and will not) trickle down to benefit 90% of end users, the other 10% actually having cash.

Instead, speculators are pricing potential end users out of today’s market. And since end users are not able or are unwilling to keep up with today’s skyrocketing prices, the price of homes will have to dip. Speculators are impatient and always leave the market at some point.

Related article:

Falling incomes, falling prices

A speculator by any other name

This knowledge takes us back to the myth that real estate prices always go up. Rather, home prices go the way of buyer purchasing power, following the mean price trendline and steered inversely by movement in mortgage rates. As purchasing power decreases due to rising mortgage rates and fewer income raises, home prices – and seller expectations – will inevitably feel the downward pressure.

Agents, beware!

So what are agents to do with this potentially market-neutralizing information? Take a look at the mean price trendline for a better understanding of future home prices.

This trendline demonstrates the mean price that real estate oscillates above and below during a business cycle. Depend on this price point for a reliable look at future real estate prices – not on the hopes that you will cash out before the next fickle, speculator-induced real estate bubble bursts.

Related article:

The mean price trendline: the home price anchor