How it all relates: Student debt, rents and mortgages

Travis Hodge
Vice president, capital markets, JLL

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The great Latin writer Publilius Syrus once said, “A small debt produces a debtor; a large one, an enemy.”

True to form, the relationship between student loan debt and homeownership rate has proven to be adversarial, as monthly student loan payments reduce one’s ability to obtain a mortgage. It’s an easy concept to grasp, but, until recently, one that was supported with few concrete facts and figures. In January, the Federal Reserve released Vol. 1, No. 1 of its “Consumer & Community Context” series, which describes the link between rising student debt and an acute decline of homeownership among young Americans.

Brian Mooney
Vice president, capital markets, JLL

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The Fed’s research shows that the homeownership rate among household heads ages 24 to 32 dropped 8.8 percentage points between 2005 and 2014. While the drop can be attributed to many factors, the Fed estimates that roughly 20 percent is attributed to increased student loan debts since 2005. Average real student loan debt per capita among the 24-to-32 age group doubled from approximately $5,000 in 2005 to $10,000 in 2014. Among their conclusions, the Fed found that a $1,000 increase in student loan debt causes a 1 to 2 percentage point drop in homeownership rate for student loan borrowers during their late 20s and early 30s.

While the Fed’s findings are based on national figures, these trends are certainly taking shape throughout Colorado. From 2008 to 2018, total student loan debt among Colorado residents increased 132 percent from $11.5 billion to $26.5 billion. Meanwhile, Colorado’s homeownership rate slipped from an average 69 percent in 2008 to an average 63.7 percent in 2018. Denver residents experienced a similar trend with total student loan debt increasing 135 percent from $6.5 billion in 2008 to $15.4 billion in 2018. However, Denver’s drop in homeownership has been more pronounced with average annual homeownership rates falling from 67 percent in 2008 to 58.5 percent in 2018.

Although Denver continues to add jobs at a healthy pace (approximately 45,000 over the last year), the majority of high school graduates consider post-secondary education a requirement to their career aspirations. For many of these students, student loan debt becomes a necessary means to an end. In 2017, 52 percent of Colorado’s college graduates owed money on student loans with the average balance at $26,530. Graduates of Colorado’s top schools often find themselves on the wrong side of that average; for example, Colorado School of Mines’ borrowing graduates left owing an average $32,221, while University of Colorado graduates owe slightly less at $27,680. Colorado’s universities have long attracted out-of-state students, but a recent trend has been the state’s increasing retention of college graduates.

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Part of the blame for Denver’s declining homeownership rate is undeniably attributed to rapid home price appreciation, as Denver area single-family home prices have increased 88 percent above the pre-recession peak, by far the largest of any metro area. MLS data indicates the median sale price of a single-family home in metro Denver was $440,919 in 2018, up a staggering 92 percent from 2011, representing a 9.7 percent annual appreciation rate. Furthermore, would-be homebuyers are discovering an additional obstacle in the form of rising interest rates. While the average 30-year fixed mortgage rate has come down from the November peak of nearly 5 percent, the Fed is expected to resume its gradual rate hike program in 2019 with higher mortgage rates anticipated.

While the struggle is most definitely real for Denver’s young aspiring homeowners, there are two sides to every story, and multifamily owners have been reaping seemingly endless rewards from first-time homebuyers being sidelined. Since 2011, average rents in metro Denver have increased an astounding 63 percent. The average apartment in metro Denver rented for $1,448 per month in 2018’s fourth quarter, according to Apartment Insights. Using the standard 30 percent of gross income-to-rent qualifier, the average apartment unit requires an annual income of nearly $58,000.

Denver residents might get discouraged when facing the prospects of renting, that is, until they consider the alternative. Assuming a 4.5 percent 30-year fixed-rate mortgage and a 20 percent down payment, purchasers of a $450,000 home can expect to pay $2,225 per month after taxes and insurance. That’s a 54 percent premium over renting and that assumes buyers are able to come up with the $90,000 down payment. Now consider the average monthly student loan payment of $345 per month on a $30,000 debt, the monthly cost of owning a home and servicing a single student loan in Denver is roughly $2,570, equating to 40 percent of the median household income.

Using the standard 28/36 Rule, it becomes clear that most prospective home buyers in Denver simply cannot qualify for a mortgage with outstanding student loans. But as John Muir so eloquently put it, “The mountains are calling and I must go.”

Despite Denver’s trying housing landscape, there’s plenty that continues to draw in new residents, including the fact that metro Denver remains an affordable rental market with average rents totaling just 23 percent of median household income. After several years of record-level apartment construction, the development pipeline is finally starting to subside as rising costs and slowing rent growth have reduced the feasibility of many projects. Many see this as a welcome change alleviating the concerns of over-supply. However, those mountains aren’t going anywhere, and Denver’s popularity continues to soar. With all the factors keeping single-family homebuilders at bay, and with condo construction representing just a fraction of the pre-defect law days, it’s not unreasonable to picture a scenario in the coming years in which Denver is faced with a worsening housing shortage leading to another period of outsized rent growth – and queue the next wave of development.

Featured in CREJ’s February 2019 Multifamily Properties Quarterly

Edited by the Colorado Real Estate Journal staff.