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House prices too high? Unless supply increases, expect them to go higher

John Clinkard
House prices too high? Unless supply increases, expect them to go higher

Alarmed by double digit increases in house prices in Vancouver (+29.6% y/y) and Toronto (+14.9%), which have sidelined a large number of first time home buyers, a number of politicians and senior bank executives are once again calling on the federal government to do something, anything, to cool demand and make single-family homes more affordable to domestic buyers.

Unfortunately, those who are calling for measures to cool demand appear to have overlooked, or at least discounted, a number of key factors.

First, over the past year, 5-year mortgage rates have trended steadily down, hitting a record low of 3.67% in May. Second, a key driver of housing demand, employment, has exhibited significant strength in both Vancouver and in Toronto.

Turning first to Vancouver, over the past year, total employment in the "big smoke" is up 6.4% y/y (+81,600). This is the fastest rate of job growth the city has exhibited in more than 20 years. Further, most (69%) of the jobs were full time.

Although job growth in Toronto is not as strong as Vancouver, over the past twelve months, the metro area has added 77,100 jobs, 91% (70,800) of them being full time. Fuelled in large part by the very positive hiring climate in both metro areas, Vancouver’s population rose by 28,700 in the twelve months ending July 1, 2015 largely on account of an acceleration in net migration. Over the past three years, net migration in Toronto has averaged +53,000.

Despite the fact that the impact of the above-noted strong fundamentals (i.e., low interest rates, strong employment and strong net migration) have contributed to double-digit gains in house prices in just six of the twenty-six metro areas reported by the Canadian Real Estate Association, measures to cool demand adopted by the federal government have applied to all home buyers regardless of their location.

These include reducing the mortgage amortization period from 40 to 25 years, increasing the minimum down payment necessary to qualify for a government insured mortgage and reducing the gross debt service ratio. The fact that to date, these measures have done little or nothing to slow price growth in Vancouver or Toronto suggests that rather than continuing to apply ineffective demand limiting measures, policy makers should focus on measures that will increase the supply of dwellings.

The fact that prices of single-family homes in Vancouver (+36.8% y/y in May) and Toronto (+17.2% y/y) have increased significantly faster than the prices of multiple units, indicates that there is an inadequate volume of single-family dwellings being built in both metro areas.

Indeed, despite strong growth of net migration, the pace of new home construction in Vancouver has remained unchanged over the past 15 years according to the Urban Development Institute (UDI). The only means of boosting the supply of new homes, according to UDI’s president Anne McMullin, is "to increase density".

Unlike Vancouver, where the supply of available land is limited by ocean and mountains, the restrictions on land use in the Toronto GTA appear to be due, in large part, to provincial land intensification requirements. According to the Altus Group, there were only 3,036 low rise (single family) homes for sale in builders’ inventories in the Greater Toronto Area compared to 16,757 units ten years prior (when the Ontario Growth Plan was first implemented).

Moreover, the province plans to further increase the density of development within existing municipal boundaries under proposed changes to its Growth Plan and Greenbelt Plan.

In a recent article, Brian Tuckey, the President of the Building Industry and Land Development Association (BILD) stated that the implementation of these proposed changes will contribute to a significant increase in population density within existing municipal boundaries. This implies that the supply of new single- family homes will continue to shrink leading to higher house prices, thereby putting a single-family home further out of the reach of more first time home buyers.

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