CD Howe Institute
Housing costs are skyrocketing across much of Canada. Price in Toronto is double what they were in 2015. Excess demand, such as that from foreign buyers, is not the cause. It is the lack of housing supply that is at the root of this problem.
In a world without barriers to construction, real estate development is a simple job like any other. Developers have to sell what they build for more than it costs them.
What are their costs? Construction workers, of course. Wood and other physical products, of course. And a loan from the bank to cover their costs until they sell what they’ve built. The cost of all of these key ingredients of a home – labor and capital – depends on supply and demand factors. When there is more demand for construction workers, a developer has to pay more for them. Lumber costs went up and down like a yo-yo. The results affect construction costs and therefore purchase prices.
Dwellings are built when it is profitable to do so. Greedy developers are not the core of the problem. If the profits from housing construction increase as demand increases, more and more developers enter. A fundamental lesson of economics is that the profitability of the construction industry will decline if there are no barriers to entry and fierce competition.
In many places in Canada and in many parts of the United Stateseven booming places like Atlanta Where Orlando, these basic economic principles determine the cost of housing. In Edmontonprices are the same as in 2015. The final purchase price of a home in Edmonton is in line with the cost of construction.
But in other places like Toronto or Vancouver, there has been a persistent gap between construction costs and selling prices. One key reason: Builders in major cities face additional costs beyond what it costs to build. For example, many proposed developments in major cities across Canada are subject to extensive community consultation. After that, the projects must be approved by the government. It’s not sure. Developers need to raise their prices to cover when their efforts are thwarted.
Process delays are a big part of the problem. This makes construction difficult. There are also barriers to growth. There is also a lack of public transport infrastructure to make the land usable. And a lack of municipal water supply to serve new developments.
It is this lack of places to build that increases the cost of land and therefore housing, not construction costs. A study found that 80% of the increase in house prices in 14 advanced countries since World War II is due to rising land prices.
How much are these additional costs on top of the construction costs in Canada? In 2018 (meaning those numbers are surely higher now), homebuyers in Vancouver saw an additional $644,000 in cost for the average new home due to supply limits. That’s $168,000 more in the Greater Toronto Area. Sales price increases at both locations have far outpaced construction cost increases in recent history.
Many will argue that high demand, not supply, is the cause of high prices. For example, places like Toronto or Vancouver attract many foreign buyers. Or they claim the money is laundered through the houses (Canada needs Major improvements So front).
But price increases caused by foreign buyers only occur due to a lack of supply. What if property developers could increase supply to match even extreme increases in demand from overseas buyers? Yes, they would pay more for wood or concrete for skyscrapers. But higher prices for wood mean that more mills would increase production. More concrete would come on the ships. These higher input costs would increase the cost of housing, but only gradually. They do not explain the doubling of housing costs.
In the same economic logic as homebuilders seeing fierce competition and lower prices if there are no barriers to entry, the best cure for high prices is more supply. Supply restrictions are what keep prices high when we have strong demand, for example from overseas buyers.
It is time for governments to seriously address the problem of housing supply as the root cause of high house prices.
The Ontario Housing Affordability Task Force report stated, “we are not building enough to meet the needs of our growing population”. House prices are rising due to lack of supply.
The report attributed the lack of supply to municipal exclusionary zoning, the power of NIMBYism, and a slow, bureaucratic process for approving new construction. It recommended sweeping deregulation of local land use, including full-right residential housing of up to four units and up to four stories on a single residential lot.
Unfortunately, the diagnosis of why housing prices have risen so rapidly is wrong, and the proposed solution is wrong.
It’s widely believed that supply hasn’t kept pace with population growth in Ontario, Toronto and other major Ontario cities — but the data doesn’t support that claim. From 2016 to 2021, Ontario’s population increased by 5.8% and the number of occupied dwellings increased by 6.2%. The population of Toronto (CMA) increased by 4.6% and the number of occupied dwellings increased by 5.9%.
New supply has grown faster than population. This has been true for 30 years. For some small towns, from 2016 to 2021, new supply increased slightly less than population; but this was due to higher than expected population growth. The supply will catch up and, in the longer term, it has exceeded the population growth of these cities. Housing construction and renovation drove GDP growth, which is hardly evidence of supply constraints.
Why then have real estate prices increased, or more precisely why do households continue to bid more and more? These prices seem unaffordable. The answer has two parts.
The first concerns ultra-low interest rates. House prices, like other assets, are driven up by falling interest rates. It’s a global problem.
The second is the role of price expectations in housing demand. When a household decides how much to bid for a home, they consider annual outlays (mortgage payments, property taxes, insurance, utilities, and maintenance), but they also consider expected capital gains. If they expect a significant price increase, the expected capital gains offset the operating costs and may even be greater – the house is affordable.
When households expect prices to continue to rise, in a way that cannot be explained by market fundamentals, the market is said to be in a bubble or exhibiting irrational exuberance. . The 2021 UBS Global Real Estate Bubble Index looked at 25 major cities around the world; Toronto was the second highest bubble risk.
This analysis focused on interest rates and expectations is used by the Bank of Canada, which considers a correction in house prices to be a major risk for the national economy. The bank has now raised interest rates and announced that it will continue to raise rates over the coming year. The bank is talking down the market, hoping to deflate the bubble but not burst it.
Admittedly, an increase in supply would moderate price increases. But even dramatic changes in land use regulations would have only a modest effect on supply over the next few years.
There is no need for the province to impose sweeping land use deregulation on local government. Indeed, adopting the recommendation that four-storey, four-unit buildings be permitted as of right on any residential lot is a recipe for policy failure. Municipal opposition would be intense and justified.
We all recognize that there needs to be increased density in many residential areas, that NIMBYism can be an issue, and that the approval process is cumbersome. But the report wants to throw out most of the local planning. The new density needs to go where there is transit capacity and school capacity. The character of the neighborhood is not something to scoff at, as the report does, but a real concern for local citizens. We need a serious policy discussion involving the province, local governments and local citizens – both those who can afford housing and those who cannot.
The report begins with a wise recommendation: to amend the Planning Act, the Provincial Policy Statement and Growth Plans to define “growth in overall housing supply” and “intensification in existing built-up areas” of municipalities such as major residential areas. housing priorities. Municipal plans will have to change. This is the framework for good policy-making.