Back to school – more training, debt and delay

For California agents and brokers to position themselves to be of service to the homebuying Generation Y, they need to understand the psychological, social and financial conditions of this age group. An intimate level of knowledge about Generation Y will be most helpful when dealing with their unique background. Due to their lack of professional and practical experience coming into this recession, they have become especially sensitive to cyclical economic downturns, and thus more cautious when long term commitments such as homeownership are involved. As students, they observed the decade-long buildup of the Millennium Boom, but are now living with and being groomed mentally by the Great Recession.

For most in Generation Y, the prospect of homeownership, though inculcated from a very early age, has likely been severely stigmatized as they bore witness to the collapse of the real estate industry and broader economy, right when they were coming of age and attempting to enter the labor force. The economic sting of the recession is all the more poignant to those who are just taking their first, tentative steps into the professional world.  The failure of government to take the effective steps of correcting the imbalance between home values and principal debt through a loan reduction, called a cramdown, has not been lost on the best educated generation we have had.

Agents must understand that Generation Y will be highly debt-laden and generally unwilling (or unable) to take on additional debt.

Agents must also understand that Generation Y will be highly debt-laden and generally unwilling (or unable) to take on additional debt – a purchase-assist mortgage. Unable to find employment, many have returned to college or university to do something productive with their time – or for lack of better options to pay or avoid immediate payment on their past student debt.

Over the past 25 years, the percentage of unemployed students has increased from 40% to 60%. The very poor job growth all through the 2000s was particularly damning for students wanting to leave the campus. These students are spending longer in school to acquire specialized training and skills that will ideally translate to high-skilled (and high-paying) employment when these jobs materialize. This is all good news for the future of California real estate values as it decreases the quantity of the permanent low-skill and low-income native-born population.

Indebted recent college graduates unable to immediately purchase

 

In the processes of their ambitious pursuit of higher-education, Generation Y is also raking up unprecedented amounts of student debt. This debt is incompatible with mortgage loan financing standards. The questionable financial future of graduates – proper jobs but improper debt – will impact the starter-home market for this decade or more.

This delay is also bad news for builders of free-standing homes. Debt-laden college graduates will in large part be too financially strapped to embark on first-time homeownership without time on the job and pay raises. Even if an indebted college graduate is interested in becoming a homeowner, lenders do not look favorably on a loan application for a conventional loan if the graduate’s total DTI ratio exceeds 41%-45%.

A high DTI ratio for total installment payments leaves a typical college graduate who wants to become a homebuyer with the singular option of FHA-insured financing. Here, the maximum payment to the lender for principal, interest, taxes and insurance (PITI), mortgage insurance premium (MIP), homeowners’ association (HOA) fees and Mello-Roos assessments, may not exceed 31% of gross income. However, much of Generation Y, suffused with a higher-education and the accompanying expectations of a better life, won’t want to settle for the price-tier of a home permitted by FHA-financing (by the time this real estate recession ends) and will thus wait until their financial condition rises to their lofty expectations implanted in school. [For more information concerning the inclusion of default insurance premiums as part of the total monthly payments of an FHA-insured loan, see the July 2010 first tuesday article, “The true costs of a default-insured mortgage.”]

Bachelor’s degree recipients from 2007-2008 graduated with an average of $23,186 in cumulative debt, and every year that number increases by $1,139. If the student continues to a graduate level education, the numbers for both undergraduate and graduate educational debt grow significantly. For students pursuing a master’s degree, the median combined debt upon graduation was $40,208 — for PhD students it was $69,754.

But what does student debt mean to real estate transactions requiring purchase-assist financing? Take a look at the recession-induced math: one in seven of the 3.3 million graduates who began repaying their college loans between October 1, 2006 and September 30, 2007 defaulted by September 30, 2008. As a result, these recent graduates have suffered a significant ding on their Fair Issac Corporation (FICO) credit score.

Thus, when an indebted college graduate who has defaulted on his student loans finally lands a well-paying job and becomes financially stable enough to pay on his student loans and a mortgage to purchase a house, which he eventually will, his FICO credit score (if it is still used) will make him a huge gamble in the mechanized eyes of today’s risk-averse lender.  As a result, he will be unable to qualify early on for a mortgage, and must wait. [For further commentary concerning the relationship between student loans and the ability to purchase real estate, see the July 2010 first tuesday article, College debt makes graduates hesitant to become homeowners; for a critical study of the relative importance of the oft-lauded FICO credit score, see the June 2010 first tuesday article, The FICO score delusion.]

Though this heavily indebted condition of graduates generally is a hindrance that will slow Generation Y’s entry into real estate ownership, this diminished economic condition is not perpetual. Pragmatic agents will take this debt-anxiety tolerance into consideration in their dealings with young buyers this decade. As advisers to buyers in their capacity as gatekeepers to the world of real estate ownership, selling agents must inform Generation Y there is nothing socially, morally or economically inconsistent with borrowing today against their future incomes – this is a proper leveraging of their personal present-value which is based on their ability to earn.

 

Taking on asset-backed debt enables the employed members of Generation Y to bring their standard of living to a level consistent with their specialized skills.

Taking on asset-backed debt – a mortgage secured by a home – enables the employed members of Generation Y to immediately bring their standard of living to a level consistent with their specialized training and skills. The alternative is waiting until middle age when they have saved up enough money to buy a home without purchase-assist financing.

Slouching towards the alter: household formations lag

Agents planning their future income, and mindful of the buying habits of first-time buyers, need to factor in the effect of household formations on real estate sales. Households, once formed, quickly shift from renting to owning.

Compounding the delaying effect of a generally late financial development for Generation Y is marriage, a requisite for most household formations. Marriage is occurring later with each successive generation in California. According to the Bureau, in the early 1970s, the average age for marriage was 21 for women and 23 for men. In 2009, the average age for marriage increased by five years: 26 for women and 28 for men, and the trend in age at the time of marriage is rising. The increased need for education to prepare for better paying service jobs is the predominate force driving this trend. The present lack of jobs is an accomplice.

As part of this trend, Generation Y is not nesting up as early as did past generations, nor are they buying homes as early in life as prior generations. The percentage of married couples to non-married couples fell to a record low level in 2009. 52% of adults aged 18 and over are currently married, down from 57% in 2000. 46.3% of adults between the age of 25-34, spanning both Generation X (those born in the 70s) and Generation Y, have never been married.

Though their entry into the traditional American adult lifestyle, and by extension the real estate market, is delayed, this transition will eventually come. Generation Y will soon blossom into a dynamic participant in the sale of real estate, but not until they find regular employment in large numbers and household formations peak, likely in the period of 2015 to 2020 during which a real estate boomlet will develop.

The urban vogue

When Generation Y does eventually get off their parents’ couch and start buying, where will they go?

Generation Y, equipped with higher-education, will soon be known as the power cohort making up the newly-educated working force of America. Those in the power cohort will likely migrate to denser urban areas, not sparsely populated suburbia as did their parents, the Boomers. Generation Y en masse will settle in urban areas ripe with professional opportunity in desirable high-paying jobs and the advantages of cultural significance; places with professional and financial centers, sporting events, museums, schools, theater, eating establishments and so on. [For more information on the reverse-exodus back to cities, see the May 2010 first tuesday article, The plight of California to be solved by…cities?]

Having acquired unprecedented amounts of higher-education, Generation Y will be able to obtain high-paying employment that takes advantage of these skills. In California, we have become a service economy, not the unskilled industrial/manufacturing economy of the distant past which adversely affects the long-term economic development of central regions of the country. Thus, a large portion of Generation Y will end up purchasing mid- to high-tier urban property reflective of their professional status, as opposed to lower tier government-financed property reserved for mostly unskilled laborers and the more impoverished among us.

As a negotiating tactic to be employed by agents representing Generation Y buyers, agents must be aware that the trappings of success will be a great motivating factor for Generation Y to buy a home. The trappings of success, such as how one dresses or the car one drives, and perhaps most importantly, where they live, will weigh heavily on the psyches of Generation Y buyers who are eager to excel in the professional spectrum. For an example, consider the dual purpose of housing on the Newport Beach coastline – shelter and luxurious style for the more successful.

Owning property carries with it a level of prestige that is highly desirable for the well-educated and nascent hard-working members of Generation Y eager to finally reach the developmental milestones of socially acceptable adulthood. Homeownership is a crucial component in the acquisition of personal power; owning property establishes a degree of longevity and civic consciousness in the chosen community.

It is the function of California agents to inform first-time buyers that it is economically prudent to build equity in a property; wealth that provides shelter, accolades and with it, power. Alternatively, and in lieu of homeownership, some of Generation Y will resort to building up cash in a savings account, all the while sacrificing their standard of living and delaying the culturally recognized milestone of homeownership.

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