Our demand for ‘more house’ helps explain high prices
House prices in Canadian cities rose rapidly over the past decade, much faster than household incomes. A narrative has developed that this is because we’re not building enough houses for our growing population. It has the intuitive appeal of Economics 101: demand for housing is up because of population growth, income growth, and falling mortgage interest rates. If supply had responded more strongly, prices would have risen but not so dramatically; ergo, the problem must be lack of new construction.
A recent Scotiabank report quantified the shortfall. Canada has the fewest housing units per 1,000 residents in the G7. If we had the G7 average, we would require 1.8 million more “dwelling units,” a truly astonishing number given that we build about 190,000 new units per year.
But there is much that is incorrect or misleading in this narrative.
From 2010 to 2020, Canada’s population grew by about 3.6 million people. How many new dwelling units would we have needed in order to keep pace? Our average household size (the number of persons per “dwelling unit”) is 2.4, so we would have needed 1.5 million new units. How many did we build over the last decade? Almost 1.9 million new units — more than enough to accommodate our population growth.
Housing is “location, location, location” so, when analyzing house prices it is important to examine the housing market of each city, not simply the national housing market. In the Toronto housing market, for example, where the rise in house prices has been extreme, the evidence about new construction is the same: completion of new units has more than kept pace with population growth.
The analysis of housing demand needs to distinguish between the demand for a dwelling unit (each household occupies one dwelling unit) and how much housing there is in each dwelling unit. High-income households want a larger unit with more, and more up-to-date, fixtures. In recent years, incomes have been rising and mortgage rates falling. That has increased the demand for the amount of housing in each dwelling unit. Again, the supply side has responded robustly. New units are of higher average quality and there has been extensive renovation of older houses. According to Statistics Canada, the value of residential renovation investment in GDP adds another 80 per cent to the value of new construction. Part of the increase in average house prices is due to this increase in the quality of units, which is not fully captured by our current price indexes.
What about Scotiabank’s estimate that we are 1.8 million units short of the G7 average of dwelling units per 1,000 people? The calculation is correct, so far as it goes. But the real story is that the average household is larger in Canada than in the G7. We have fewer units per 1,000 people but we don’t have fewer units per 1,000 households. In other words, there’s no structural supply shortage. Indeed, in terms of square feet, we have much more living space per person than the G7 average.
When analyzing house prices in a large city, economists use both the standard supply-demand model of Economics 101 and a “circular city” model. The broad pattern in cities is that jobs are concentrated in the centre and housing is built up around this centre. Households commute from where they live to the city centre. The same house near the city centre has a higher price than in the suburbs; households bid up the price of central housing because they can save on commuting.
In equilibrium, a household is equally well-off living in the centre, in the suburbs, or at the periphery. When population and employment grow in a city the housing market expands outward, but the price of housing increases all across the city — even when supply does respond. That’s why house prices are higher in big cities than small. Also, if the share of jobs in the centre grows or the centre becomes a more attractive place for shopping and entertainment or if the money and time costs of commuting rise, the price of housing increases across much of the city — again even with no supply constraints. All these forces have been driving up average house prices in Toronto and other large cities.
It’s no surprise, then, that houses are becoming less affordable for first-time buyers in Canadian cities. But high house prices are not, fundamentally, caused by lack of supply. So long as both incomes and the share of our growing population living in large cities continue to rise, so too will house prices.
CANADA HAS THE FEWEST HOUSING UNITS PER 1,000 RESIDENTS IN THE G7.