By: Mark Kerzner, President & CEO, TMG The Mortgage Group.
In Economics 101, we learned the basics of supply and demand. Equilibrium (and ultimately prices) are determined where the supply and demand curves intersect.
If supply is constrained and demand stays constant or increases, prices rise. If supply increases and demand stays constant or contracts, prices fall.
Unlike other sectors, the housing market is slow to respond but that doesn’t mean it is not responding.
No Quick-Fixes
According to Lawrence Smith, Economics Professor Emeritus at the University of Toronto, "there are time lags – a slow market adjustment – but that doesn’t mean it is not adjusting. This market is characterized by permanent disequilibrium, but usually moving towards equilibrium."
Smith goes on to describe the housing market as a stock of what's available, and a flow (new production and turning over existing units). There is currently a reduction in the flow of supply, which has led to a huge bump in prices.
Flow supply has been temporarily down for a few years, but when you look around the Greater Toronto Area, you can't say there isn't a huge supply response. In some cases, instead of building 20 stories, developers are now going 60 floors, tripling the effective availability of land in certain areas. On the other hand, there is further contraction of the flow because "people are not putting their houses on the market."
Ultimately, though, the question remains: is this just a moment in time where before the market will respond with a correction, or a trend that requires some action?
On a recent TMG The Mortgage Group Town Hall meeting, industry expert Ben Rabidoux, founder of Edge Realty Analytics, described the current market situation as a "stunning shortage of inventory." He added that, "this was the first recession where households came out ahead of where they went in."
Benjamin Tal, Deputy Chief Economist with CIBC, agrees. "I think we are underbuilding by 20,000 to 30,000 units per year," he said. "The fundamental issue we are facing is lack of supply." Tal also believes we are underestimating household formations in Canada, saying, "The supply-demand mismatch is worse than they [Statistics Canada] are telling you."
Even though housing starts have picked up again this year, its impact on supply is still somewhat limited since it takes time to get from the start of construction to the move-in stage. "The average timeline has more than doubled over the past two decades, from 9 months to 21 months," Scotiabank noted.
With Huge Demand, Where’s the Supply Response?
Where there is imbalance there is often opportunity. In this case, with the lack of current housing supply, one would expect businesses to seize those opportunities and fill the demand by building more stock. Is that indeed the case? Why is there a huge gap?
It would appear that time and supply chain constraints, along with a mismatch of government interests and priorities, are exasperating this imbalance.
The Liberals, in their most recent election platform, put forth the following election promise: Invest $4 billion in a Housing Accelerator Fund to build 100,000 new middle-class homes by 2024-25. How impactful would 100,000 new houses be in three years (30,000 per year)? How does the money get deployed? Why hasn't the private sector already taken this opportunity?
When asked this question, Professor Smith asked replied, "What is the constraint on the supply that the [Federal] government is going to remove to bring on 30,000 new starts per year? There isn't one. There is no financing constraint. If there is a land constraint, it is not a federal government issue. That would need to be addressed with [municipal] zoning, and if they are going to bring in more services to enable more land development, that won't happen in three years."
Governments must be aligned to make headway on this issue. It is great that the federal government is promising $4 billion, but they need municipalities to help execute their plan. This would include the costs and delays to obtain permits and limited availability of usable (developable) land.
In some respects, the federal government would be more effective if it transferred $4 billion to municipal governments to empower them to create efficiencies, provide land and speed up the process to get annual housing starts to 280,000 and beyond for consecutive years.
Even though there appears to be gaps in current supply levels, according to a recent RBC report, there are more housing units under construction now than at any point in our history – and "about three-quarters of the total are apartments (mostly condos but also rental)".
A Long-Term Approach
Supply chain issues and soaring construction costs are likely to persist, further delaying completion dates in the immediate future, however, over the mid- to longer-term, those issues should be resolved.
Housing solutions require long-term thinking. Regular election cycles (and the desire to be re-elected) often involve short-term promises. Why invest billions of dollars in something that many constituents may not see until well after the incumbent leaves politics?
Tal agrees that solutions require long-term thinking and are multi-faceted. "When you are desperate, you come up with solutions – it is a long-term play," he said.
He cites a number of different areas where focus needs to be placed, including working with municipalities to update zoning by-laws, allowing and encouraging people to build, encouraging innovation, encouraging inclusionary zoning (where builders are given incentives to incorporate low-income housing units in their developments, which allow higher density) and accelerating incentives to drive purpose-built rentals.
Factors at Play
There are some headline trends we should continue to keep an eye on that will impact both demand and supply factors:
• The return of pre-Covid immigration numbers
• The return to (office) work vs. work-from-home
• Preferences to live in single-family and/or outside major urban areas
• Densification in urban areas – which may run into conflict with current homeowners
• The desire to grow greenspace
• The willingness of would-be homeowners to be renters (and fill the vacancy gap)
Clearly, these are complicated issues. Our current environment suggests that current housing stock and/or flow are at low levels, which are leading to high prices. Demand factors are likely to persist, keeping upward pressure on price levels.
There appears to be more supply coming online, but longer-term solutions, especially from municipal levels, are needed to reduce the friction to help new starts get back to the levels needed to achieve market equilibrium in a more timely manner.