Author: Steve Pomeroy

Over recent years, many Canadian cities have seen significant inflation in home prices, raising concerns about the ability of young first-time buyers to get onto the home ownership ladder.

There is some debate as to whether this is a result of a lack of supply or a result of excessive demand. Of course, both contribute to this phenomenon but it’s important to better understand the respective contributions before we can start to identify possible solutions. This is the first of a three-part blog to explore these issues. Blog 1 first examines the case for insufficient supply; Blog 2 then examines the role and nature of demand. Blog 3 concludes with a discussion of some policy options.

Part 1: Is insufficient supply the cause of excessive price trends?

Many housing industry advocates and analysts, have commented on the trajectory of home prices and assert that this is a result of insufficient level of new home construction, relative to population growth.[1] They further postulate that this is largely associated with slow and onerous municipal development approval processes. And these sentiments are reflected in recent election platforms that proposed to increase supply and target municipalities to accelerate and expand new construction, with the expectation that this will help to contain price escalation and thereby enable young families to access homeownership.

It is well accepted that housing markets are typically characterized by inelastic supply and an inability to respond to rapid changes in demand. Put differently, it takes considerable time—generally 3-5 years—to plan and build new housing, while migration (international as well as domestic) can swell in a short period (e.g. Alberta cities during oil boom). This can cause short-term price surges.  But over the longer term, in the absence of market failure, supply should catch up to demand levels.

The suggestion that there is a mismatch is largely based on the belief that higher levels of immigration have increased the population and supply has remained at lower levels. However, the data does not support this assertion.

In order to dispel this myth, this assessment looks first at immigration and the associated population and household growth. It then compares this to new home construction.

It is true that Canada has increased immigration targets and this has added new households.  Over the past decade, Canada’s population has increased at an average of 412,000 people per year. Just over one-quarter (26%) is due to natural growth. Of the other three quarters, just over two thirds is net immigration (56% of population growth). The more notable component is from non-permanent residents (NPR) – which includes temporary foreign workers and increasingly, foreign students. [2]

And, as illustrated in the chart below, the number of NPRs has substantially increased, especially between 2017 and 2020 as post secondary institutions have targeted lucrative foreign tuition fees to offset reduced government funding. This group is significant because, due to their temporary nature, their impact is more on the rental market, not the ownership market, although if they subsequently become landed immigrants their tenure choice may evolve. So, their initial impact is on rent inflation, more so than on home prices.

How population (persons) growth translates into housing demand and what type of demand is also important. Over the decade 2006 to 2016, Canada’s population increased by 17.1%; but the number of households increased at a slower rate of 13.2%.

This was because the average number of persons per household increased.[3] A contributing factor was that we added families and lost aging seniors – a trend that will continue as the baby boom ages. In addition, as (some) empty nesters shift their housing choice to smaller dwellings they free up the larger family home for new families, creating some adjustment in housing requirements.

The key piece of data is that:

• Between 2006 and 2016, the number of households in Canada increased by an average of 163,000 per year.
• In comparison, new housing construction over that same decade added 1.92 million homes, an average of 191,900 per year.

This comparison does not consider any impact of demolitions and loss of existing homes. Data on building permits for demolitions is sparse, but suggests this a relatively small number.[4] Nor does it consider the use of some dwellings as temporary vacation units under platforms such as Airbnb, which remove residential units from the stock. So in certain cities (and especially GTA) there may well be some degree of insufficient supply, but this is not replicated in many cities that have similarly seen persisting rising prices.

And contrary to arguments that we have an accumulated shortage of houses, there was already some slack in the system. In 2016 the census reported a total dwelling count of 15.4 million. It reported that only 14.1million of these were occupied by the usual resident. So there were 1.3 million homes (9% of all stock) vacant and available to fill demand.[5]

This reveals that at a national scale new home construction through 2016 has far exceeded the growth in households and thus demand, by almost 30,000 units per year. As such it does not support the explanation that home price increases 2006-2016 were caused by undersupply.

Acknowledging that a disproportionate number of international immigrants target the larger metro regions an examination of the pattern of household growth versus new home construction at the local level (2006-2016) reveals very mixed results. In Vancouver, Toronto and Montreal, new home completions exceeded household growth by 19%, 1% and 4% respectively. Only in Ottawa was there a deficit (3%) of homes over households. On this basis, if supply was the key driver, prices should have increased much faster in Ottawa and less in Vancouver, but price trends increased by only 47% in Ottawa versus 97% in each of Vancouver and Toronto, confirming that factors beyond a supply mismatch were at play.

Data for 2021 is not yet available, but it is possible to use estimates from population and household projections to examine the trend over the most recent five years.

For the five years since 2016, the previously referenced data on components of populations growth identify an uptick in annual population growth and this will have required additional home construction.

Earlier projections for household growth generated by CMHC in 2015 estimated total households in 2016 and through to 2036 under low, medium and high headship and immigration scenarios.

The low projection was for a total of 14.7 million households, which is well above the subsequent 2016 census count of 14.07 million.

Ignoring that the baseline (2016) is higher than the 2016 census count, anticipated growth for 2016 to 2021 under the three scenarios estimates annual household growth of:

• Low                 104,100
• Medium          170,700
• High                241,000 

The evidence from 2006 to 2016 suggests that the high growth projection (241,000) is excessively optimistic and even the medium estimate is likely on the high side. Nonetheless using this medium projection suggests a need for an additional 170,000 homes per year. Actual completions for 2016 to June 2021 have averaged 196,700 homes per year.

Switching to starts data (rather than completions, used above), which reflect current market response, there is a clear upward trend. Annual starts totalled just over 180,000 in 2015. They reached a high of 202,600 in 2020, despite Covid changes in the supply chain. And in the four quarters 2020 Q3 through 2021 Q2, reached a new high of 238,000, confirming that there has been a market response to increasing demand.

So again, there appears to be an adequate supply of new homes, at least at a national aggregate level.

It is of course possible that these are not distributed in alignment with differing rates of household growth in different cities. International migration tends to focus on the larger metropolitan areas, so there may some mismatch there, and this could partially contribute to higher rates of price escalation in Vancouver and Toronto.

There may also be a mismatch in the type and price of homes relative to requirements in different locations. Certainly, many families aspire to a detached home, but new construction, especially in large higher cost metro regions has increasingly added small (often very small) apartments.

The shifting preferences during the Covid pandemic highlighted this issue, and, abetted by working from home, contributed to a suburbanization and exurbanization of demand.

The key point here is that while new home construction may have fallen short in a few cities, it does not explain the more widespread pattern of price increases. Nor does it explain the variations, as illustrated above for 4 larger city/metro regions.

Misleading use of term “housing supply”

A related issue is the way the term “housing supply” is used. Discussion of home prices in the media frequently refers to low supply of homes. But this is a different conceptualization than new construction.

In analysis of home sales, the term is used to refer to the number (“supply”) of homes for sale, or more precisely number or inventory of listings. When there are more households seeking to buy than those seeking to sell, including newly constructed homes, this creates a mismatch and places pressure on prices. This phenomenon was exacerbated by pandemic-related reluctance to list homes juxtaposed against a reported shift in housing preferences toward larger detached homes to provide space for home-based work.

The lack of listings is a different cause of “undersupply”. While expanding new construction might add additional choice, this is a delayed process. Covid created a temporary surge in demand, but it was impossible to accelerate construction. And in some jurisdictions construction activity slowed due to Covid safety protocols. However, as noted, nationally starts are ascending and reaching new record highs, so may catch up with this demand.

Policy Implications

Overall, the evidence reveals that there is not, in fact, an insufficient level of new home construction (except perhaps in a few cities), although there is a low level of listings for sale. And we may not be building the right type and size of homes in the right places nor at affordable prices.  In the rental sector the years prior to Covid saw declining rental vacancy rates, especially in smaller university cities – a result of increase foreign student NPRs. So there are supply issues, but the quantity of supply is not the main problem. Nor is it the primary cause of escalating home prices (although it is for rents).

While immigration has been muted by border closures during the pandemic, it is poised to return, so there will be increasing housing demand. But immigrants, especially the significant proportion that are non-permanent residents (NPRs) will more likely seek rental accommodations than seek to immediately purchase. So, the price pressures will be more acute in the rental part of the housing system but will therefore have a more modest impact on home purchase prices (except when being purchased by investors). 

Another aspect of the insufficient supply argument is that it tends to focus on the municipal regulation and approval process as the key impediment to expanded supply. There is little if any discussion about other parts of the supply chain. In each local market is there a sufficient supply of land, skilled labour and materials to support expanded supply?

During Covid an expansion in renovation activity created a shortage in lumber and inflated prices. Any attempt to substantially expand new construction will similarly run into constraints in the supply chain, and rather than improve affordability could inadvertently fuel price increases. [6]

In the face of demand from a small group of well-endowed purchasers, armed with excessive capacity to pay, prices will flow to the level that the market can bear.

Expanded supply does not necessarily lead to lower cost and more affordable supply. The key issue, driving up home prices, as will be discussed in part 2, is the nature of demandand the impact of “supercharged” purchasing power, enabled by accumulated equity, higher incomes and historically low mortgage rates.

---

[1] For example, Scotiabank Global Economics May 2021 Estimating the Structural Housing Shortage in Canada: Are We 100 Thousand or Nearly 2 Million Units Short?

[2] A non-permanent resident is a person who is lawfully in Canada on a temporary basis under the authority of a valid document (work permit, study permit, Minister’s permit or refugee) issued for that person along with members of his family living with them.

[3] Average household size increased from 2.41 (2006) to 2.50 (2016), confirming that using homes per capita, as used in the Scotiabank brief, is imprecise.

[4] Statistics Canada. Table 34-10-0066-01 (Building permits, by type of structure and type of work). Total demolitions likely represent around 5% of total starts, thus lowering or eliminating the gap between new households and new homes in some cities, notably Toronto.

[5] This had increased from the 1.14 million unoccupied dwellings (8%) in 2006. Some may be vacation homes; others empty investor units targeted by vacant home taxes, as well as short-term rentals.

[6] In Australia which reports similarly escalating home prices, the federal government has introduced supply stimulus. The result is a dire shortage and inflation in prices of lumber, which in turn is causing further increases in home prices, not contributing to containing or reducing price growth. https://www.abc.net.au/news/2021-06-21/australia-victoria-housing-building-boom-timber-supplies-cost/100229612