Will Millennials Cause Deflation in the Housing Market?

Lately, there have been a lot of articles written about millennials. Some have hit pretty close to home for me, seeing that I am a millennial. But I decided to dig a little deeper to see what exactly the future may hold for me when I finally finish my bachelor’s degree at the University of Oregon. I was startled by the price of homes around the Pacific Northwest, my desired region to live in. Sadly, this will cause not only myself, but many other millennials, to rent an apartment. After a while of thinking about the demand shock that this will likely cause, it started to beg the question: Will millennials cause a little deflation in the housing market?

Got Any Savings?: 20 Percent Down

If you’ve ever decided to look into buying a home like most other Americans have, you likely know that an industry standard is 20 percent down on your mortgage. For perspective, this means that for every $1,000 you’re looking for in a mortgage, you need $200. For a $300,000 home, this means you need $60,000 ready to use on a home. According to a GOBankingRates survey, between 31 and 33 percent of millennials have absolutely nothing in savings. Since we’re talking about real estate, the real question to ask is, “What percentage of millennials have more than $10,000 in savings?” Especially if we expect this generation to have a 20 percent down payment ready.

The survey reports that only 8 to 15 percent of millennials have $10,000 or more in their savings account. Both groups of young and older Gen Xers reported just 16 percent in this category. Baby Boomers? Only 17 percent of them reported in this category. Only seniors showed more than 20 percent reporting more than $10,000 in savings. Now that millennials are getting to the age where previous generations started buying homes, economists should consider what’s going to happen if there is a demand shock where hardly anybody buys a home.

What it Takes to Buy a Home

A good entry-level job in my field in the Seattle area pays around $60,000 per year. This is $5,000 per month. Of course, when you are paid $5,000 per month, you really only get about $4,000 per month because of tax withholding. As a rule of thumb, it is said that if housing costs more than 1/3 of your income, you are overpaying for housing (definitely the case for most millennials). Since most people don’t understand the math behind finance, using a financial calculator, I have taken the liberty of calculating what it takes to buy a home with $60,000 per year.

1/3 of $4,000 is $1,333.33. Using a financial calculator, with $1,333.33 as the payment and 4 percent as the annual interest rate, I could only afford a 30-year mortgage of $279,280.96. As nice as this sounds for someone with less than desirable credit, we’re forgetting something: The 20 percent down payment. 20 percent of $279,000 is $55,800. As stated earlier, only 8 to 15 percent of all millennials, maybe a little more, will have more than $10,000 in savings. How much more is a question that should be explored further.

 

$15 Minimum Wage Not a Long-term Solution

A long-term solution usually isn’t by forcing people to pay more for their workers. After all, with every minimum wage increase comes an increase in the employment taxes (not the same as FICA or worker’s comp paid by the employee) paid on each and every worker by the employer. One reason why real estate is so expensive in certain cities is due to the fact that some people actually have the money to quickly buy a house and have money left over. Portland is a prime example of this.

Imagine you and some friends have jobs in the tech and financial industries. Some of you are financial analysts. Others are accountants. Some are investment analysts. Few are the tech developers. You’ve all got between $200,000 and $300,000 saved for a down payment on a house (look at San Francisco home prices if you don’t believe me). Imagine one of your friends tells everyone that you could all likely find the same jobs with similar pay in Portland, Oregon and have a lower cost of living. After doing some research, you thought you’d apply for a job, just for fun, and you got an interview. After being offered the job with a slight pay cut of $3,000, you find out that you can buy a house for $200,000 and have $100,000 left over. Would you make the move?

What happened in Portland is that there were many who moved from San Francisco for investment jobs and many from Silicon Valley for tech jobs. There were even people who moved from Californian companies to Oregon for jobs in companies based in Portland and Eugene. But has much changed in California? The point is applicable to the $15 minimum wage we keep hearing about. On paper is sounds great for low-wage earners. But in reality, people will get priced out of their homes and will have to move. Some will find better opportunities much like the many Californians that swarmed up to Oregon for a lower cost of living, which is getting out of hand. A $15 minimum wage won’t actually help this issue; sharp minimum wage increases will eventually exacerbate the issue.

The Post-2008 Housing Bubble

Sometime in 2015, the S&P/Case-Shiller home price indices have shown plenty of home prices in metropolitan areas of the United States increase back to pre-2008 peaks and many have even skyrocketed past that level. When something like this happens with housing prices and when we don’t have enough people fueling that increase by buying homes (like right now with millennials), we have evidence of a bubble. Luckily, when the bubble pops, we shouldn’t expect to see the financial crisis we saw in 2008 repeat itself. Some of this is thanks to Dodd-Frank. Some of it is thanks to how cautious people became of buying a home after 2008 (which makes Dodd-Frank somewhat of a safety net, if you will). Of course, it may not have been officially declared as a housing bubble, but I’m going to confidently say, in my professional opinion, that we are in a housing bubble again.

fredgraph

Blue Line: S&P/Case-Shiller US National Home Price Index; Red Line: S&P Case-Shiller 20-City Composite Home Price Index

Millennials May Pop the Bubble and Create a New One

So what can we expect when the bubble finally pops? As aforementioned, I do not believe we will see a repeat of 2008. But deflation and unhappy home sellers are surely going to occur. How sharp will it be? When will it happen? I’m not sure. But I know that millennials will continue to rent until they have the money for a house. So while the housing bubble pops, a rent bubble will eventually replace it. If millennials buy houses again in 10 years, then we will see fewer people renting apartments. So what happens here?

Just as we are likely to see deflation and unhappy home sellers, we are likely to see some deflation and unhappy landlords that can’t fill their apartment complexes. Perhaps a rent bubble will be created. In an oligopoly, such as real estate, we can only suspect through economic intuition that a surplus of apartments will occur and the price thereof will dwindle down until people see value in rentals again.

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