While opinion pieces are interesting - keep in mind, they are just opinions.

 

     I came across an article in the Globe and Mail yesterday titled, "Politicians are selling us a myth on housing: that more supply will be our salvation" by Gary Mason. While these kinds of articles always make for an interesting read - and always sucker me in - thus fulfilling their purpose.

     In response to the author's statement, ultimately - no, the writer did not magically find some exception to the rules of supply and demand.

     While Mason makes a convincing argument that is easy to follow and easy to believe - the crux of the argument is that building more supply won't fix the problem because we are building luxury units for investors and the rich - if we want to solve the problem we need to restrict demand, not fix supply, this is clearly true because they are building highrises in Vancouver, and affordability has not gotten any better.

     Ok - let's address the problem in the arguments.

     First, as repeatedly mentioned, yes speculators and massive real-estate investment are a concern - but it is important to recognize that these actions are a symptom of the problem, not the problem itself. You could not make money in real estate if we were not supply-constrained pushing up the price. Thus it is because of the supply constraints that investors are attracted to real estate because they know as long as supply continues to be constrained, they can continue to make money. Thus to say it again - real estate speculation and investment is a symptom, it in itself is not the problem. Like with medicine, if we chose to just treat the symptoms, we may feel better, but we will just be ignoring the root underlying issue.

     The next issue is that the author, Mason, believes that somehow he has found a situation where the rules of supply and demand do not apply. Mason brings up the fact that despite a high-rise with several hundred units being built, they were all sold off and did nothing to improve affordability. Let me make a similar argument and we can judge how it holds up - it is an analogy I have used before.

     Imagine a case where the water in your kitchen is stuck on, there is no way to turn it off. similarly, while your kitchen drain is working, it is a little clogged such that water is entering the sink faster than it can be drained out. The result - the sink is filling with water. For whatever reason, you ignore this until the sink is near the top and at risk of spilling over onto the floor. You decide that maybe, to prevent the water from spilling over, you can scoop it out with a cup. You do so, but the water keeps rising - clearly, this is not a solution. (Mason's argument).

     Again, in our case - this is analogous to our current housing situation, the flow of water is our population growth - there is no ethical way to turn off the water. As the sink fills, prices rise - If you can fill up cups just as quickly as the flow of water, there is no change. If you can fill up cups faster than the flow of water, then the overall level in the sink decreases, and prices will fall. When the sink gets full and starts flowing over, well that's when we begin to get all of our negative social spill-over effects due to the unaffordability of housing.

     To add to the problem - you have a friend in the kitchen with you who is, chaotic evil, and just wants to watch the world burn. As the sink gets fuller and fuller they are getting more and more joy as the spill-over is getting nearer. Thus, as a result, this friend starts to take a few empty cups and puts them "away" so that they cannot be used to bail out water.

     Mason is arguing that the sink is on the verge of overflowing because the friend is hiding cups, ignoring the fact that the reason the sink is overflowing is that we are not bailing out enough water. While it is easy to blame the friend in this situation - the friend is just being opportunistic given the situation and their nature - the problem at hand is not the friend, but the rapidly filling sink. The solution is not a blame game but rather to get more cups to get more water out of that sink as fast as we can.

    Note: To be clear - it works in this analogy to have the 'friend' be chaotic-evil because there is no other real reason why they would want the sink to fill with water. This is not saying that landlords / real-estate investors are chaotic-evil. In the real world, the rising water (prices) gives them a real payoff and an incentive to continue to hold onto cups (property) - they benefit as long as the sink continues to fill, in this case, they are doing the same as anyone would do if they had the opportunity - trying to make a better life for themselves.

     One of the final points Mason makes that needs to be addressed is that these highrises are building lots of "luxury" units versus entry-level units - thus not really helping. Keep in mind, there are people out there that either (A) make lots of money, or (B) are chronologically blessed and entered the housing market decades ago and are now exceptionally wealthy. Both of these groups want luxury units and are willing to buy them. If these luxury units were not being built, then these two groups would continue to compete with everyone else for the same few units that exist. By building these luxury units, these individuals either are not competing with you for your normal unit or alternatively are the ones selling these regular units as they upgrade to a newer luxury one.

     Finally, I feel it is important to keep in mind, that builders are running a business, they will build what demand is dictating. to make another comparison - a baker will only bake the bread that they feel will sell during the day, If the baker only makes cheap white bread, all the customers are left buying this. If the baker makes loaves of varying quality, then consumers of different means can purchase the bread they desire. The baker will not produce only the most expensive sour-doughs if they do not believe these will all be bought - after all, the baker does not do their job out of concern for your well-being, but rather they do their job out of concern for their own well-being. In this way, the baker will provide the varieties of bread that will sell the best, to maximize their own well-being. We do not fault the baker or any other business owner for this, similarly, we should fault the builder either.

     Always interested to hear your thoughts and opinions on this - feel free to comment below.

 

 

Affordable Housing

 

    I often hear the term "affordable housing" being thrown around. "We need more affordable housing" or "Why aren't these units affordable?" This begs the question - What is meant when we say affordable housing? A follow-up question might be, how did housing become unaffordable? 

What is affordable housing?   

    To start off - What is affordable housing. Unfortunately, there is no universally agreed-upon definition for this. Some define affordable housing simply as "non-market" housing, that is a unit that is purposely sold for less than the current market price. It is prudent to remember though, that just because something is being sold for cheaper, this does not necessarily make it affordable. 

    One of the most commonly used definitions of affordable housing is the one used by the Canadian Mortgage and Housing Corporation (CMHC) which states that housing is considered affordable when less than 30% of a household's gross income goes towards shelter costs. 

    Why 30%? where does this number come from? This number is simply the value often offered by financial experts as a maximum shelter expenditure that still allows adequate money left over for food, utilities, etc.  But keep in mind, this 30% value is simply a rule of thumb with no good reason as to why it is an optimal value. That is, it is quite easy for two different households to be spending 30% of their gross income on shelter, but have very different financial situations depending on their number of kids/dependents or health concerns/costs, etc. As such it is important to recognize that this 30% rule is a standard definition for affordable housing, but that does not make it a perfect definition. 

    So how does this 30% rule work in the Capital Regional District (CRD)? Unfortunately, the income tables from the 2021 census are not released till later this year - so we can make our best guesses given the 2016 census. 

 The Data

    In 2016, the median household income in the CRD was $70,283 (StatsCan), compared to the 2006 census, this shows that median household incomes grew, on average, 1.09% a year over this ten-year period. If we assume that median household incomes maintained a constant growth rate, this would put us at an estimate of $78,337 for median household income for the CRD in the year 2020 (the 2016 census estimates 2015 data).

Note: Median is the middle value, this means that 50% of households in the CRD would earn more, while 50% would earn less. 

    Thus, if we assume that the median household income for the CRD is now, roughly, $78,337 - this puts an affordable, rental rate at $1958/mo. for the median family. This means that at a rental rate of $1958/mo. only the top 50% of households would find this rate affordable - as defined as being less than 30% of their incomes. 

    What about purchase prices? Well, things get a little more complicated - given current prices we need to assume that we are only considering condo/townhomes, meaning that there are strata payments. If we assume a strata of $175/mo, this would leave $1783 available for a mortgage payment. If we presume a mortgage rate of 5% (given higher stress test requirements), this median household's affordable mortgage would be about $305,000. Throw in a 5% downpayment, subtract out closing fees and insurances, and you get a purchase price of a little more.

    As you may now be aware - these rental and shelter prices are becoming exceedingly unrealistic - meaning that based on the rule of 30% gross income towards shelter = affordable, we are finding that by far and large the median household cannot find affordable housing. To put this another way, over 50% of households would have trouble finding affordable housing in this market. 

    Now - why do we not see such massive homelessness? clearly, if over 50% of households could not find housing we should see people in camps everywhere right?! The vast majority of these households - were able to secure housing before the prices jumped - for them, as long as they can maintain their shelter, or access the equity of their house, they are stably sheltered and they face no problems - it is the future generations and those who were not able to obtain secure shelter earlier that are left out in the cold. 

    How did we get here?

    In the case of shelter, or any good, if we have more demand for the good than there is supply, we would say we have excess demand. In this case, we have lots of people who want it, however only a few who are able to sell - as a result, we have 2,4, or more people trying to buy each unit that comes available. How do you ensure you are the one who gets to buy the thing you want? You offer a higher price! who amongst us as a seller would say no to being offered more money? In this way, prices rise. 

    Locally, and across most of Canada, over the last several decades we have had our typical growth of population through birth rates and immigration, however, the development of housing has not kept pace. That is, we have had only slight increases in supply over the last several decades - this slow supply growth is often attributed to restrictive zoning and community groups rejecting development over fear it would change the nature of the neighborhood. In reality, we've seen this all around the world, as soon as you become a home-owner your aim is to protect your investment (your home) if you can restrict development around you, your asset price increases, and you are better off. Unfortunately, we rarely consider the consequences this has for our children and future generations. 

    Now on its own, this would have pushed prices higher, and made housing more expensive - but likely would not have led to the extent to what we see today on its own. 

    Over this same period, we have witnessed a relaxing of many mortgage lending rules (specifically in the early 2000s) coupled with record low-interest rates and a new view of real estate as an investment commodity - and one that banks were more than willing to easily lend money to allow people to buy. As a result, those who could access credit could purchase a second home, or maybe even a 3rd or 4th. All of this creates even more demand for housing given a relatively constant supply.  

    So to recap - supply was been restricted, and demand has continued to grow through natural population growth as well as a rise in speculative demand. the result, is a massive amount of excess demand, putting upward pressure on prices. 

The Solution.

    The problem is a lack of supply. If we want to ensure that our children can choose to live in the same community that they grew up in, we need to ensure we are building enough to house them. That is, we need to increase supply, we need to build more in a thoughtful, responsible, sustainable way that creates a livable community for current and future generations.

Note: Many say the solution is to restrict all this excess demand due to speculators. While this would help, it turns out they are a small part of the problem - this is discussed in a previous post here.

    As we can bring more units online we can increase the supply, and begin to match all the pent-up demand. Of course, the kick-back is always "We have been building, yet prices still keep rising". My response to this is twofold. 

A) Yes, of course, prices are still rising, there has been so much excess demand that building a few hundred units hardly absorbs the difference! 

B) We still have speculators out there who believe that the market will keep rising, and money is still to be had by buying and flipping properties, although this appears to be a smaller effect than many believe.

    As long as demand exceeds supply, prices will rise. to stabilize, or reverse the price trajectory, we need more homes built for people to live in. Emphasizing people to highlight the fact that we need policies in place to prioritize homes for living over investment. 

   A further kick-back or criticism is always "Why here. Municipality XYZ isn't building anything!". Unfortunately, this is always a problem. Truth is, building, development has growing pains and costs, being part of the solution is not easy, but it is necessary. this problem is actually akin to climate change. Climate change is a global crisis with real costs to combat it. It is always easy to say "Why should we change our lifestyle to combat climate change when country XYZ isn't doing anything". The answer is really the same to both questions, it's because if not you then who is going to? 

     Local regions and municipalities only have so many tools at their disposal. While the municipalities that harness these tools to face this housing crisis head-on have the ability to transform themselves into amazing vibrant communities where families want to grow up and stay, communities that continue to attract the best a brightest from around the world. It is these communities that have the potential to be leaders and forge ahead post-crisis rather than being left picking up the pieces and playing catch-up. 

    This means changing zoning to allow for greater densification to allow more units to be built. this means recognizing that people need to recreate, we need community hubs, parks, and urban green spaces. this means communities that are designed to promote active transportation with investment in the required infrastructure for easy public transport and decarbonization. 

    This means municipalities taking a stand to combat rising prices, the Canadian Centre for Policy Alternatives recently released a report pushing for more support for non-profit community rentals. This is within the scope of municipalities to build public, non-profit, rental units on a cost-recovery basis. Doing so provides many more units to the community at significantly cheaper market rates, helping to address affordability, all the while keeping these projects self-supporting - that is, the burden of these projects won't fall on the taxpayer. 

    This is not an easy task, but we are currently confronted with the joint housing and climate crisis giving us the opportunity to engage in a massive infrastructure project arguably not seen since the end of the second world war. We can either continue on with a business as usual case, or we can address these crises' head-on, face these costs, and build a better tomorrow. 

    As always housing is an extremely delicate issue where emotions run hot amongst those with and without access to shelter. What are your thoughts on this? feel free to comment below. 

New inflation values out today - be careful how you interpret this!

     

    TL;DR: When StatsCan measures changes in prices, they do so for a fixed basket of goods - this includes maintaining quality at a fixed level. When the quality of goods increases over time this creates problems - especially when consumers cannot choose to still purchase the lower quality good for a cheaper price - the result is that the actual inflation of this good, likely, is significantly more than the posted rate of inflation.     

    A common argument is that the average household today is better off than John D Rockefeller because we now have access to microwaves and the internet. Thus, this drastic increase in the quality and availability of new goods must mean that we live significantly better lives. The real question is, can we honestly compare the standard of living across such an expanse of time given drastically different goods, and the quality of goods available. 

    Just the same, an attempt at this adjustment is used in calculating the Consumer Price Index (CPI). recognizing that we have access to superior quality goods today Vs what we had 10, 20, or 30 years ago. This improvement in quality must be accounted for in computing the change in the price of a fixed basket of goods. 

    I talk about this a lot with my students - CPI inflation is intended to be a measure of the change in aggregate consumer price levels for a fixed basket of goods to provide information to policymakers regarding how consumer prices have changed year over year. This provides insight as to what has been happening with prices, but it is not the full story and it is not a good measure of the cost of living.

    But first, why is this problematic? This is problematic as the CPI measure of inflation is often used by employers, pensions, unions, and others to determine the change in the cost of living. This leads to the thinking "Oh, CPI inflation was 2% last year, so as long as I get a 2% pay raise I am no worse off". Unfortunately, as we will see - this may not be true. Specifically, your observed rate of inflation may be significantly higher than the reported CPI inflation - basically, the problem comes down to assumed substitutability.

    (This helps to explain why even though wage growth has been slightly higher than CPI inflation, the average wage earner today feels as if their purchasing power is less than it used to be)

    To evaluate this, let's focus on the aspect of CPI inflation, rented accommodation - while shelter costs on whole are weighted as 26.8% of the CPI basket of goods, rented accommodation accounts for only 6.4% of the total CPI weighting (because we assume that most households are owners - however, a similar problem exists for owned accommodation as the problem we discuss here).

    To begin, we can look at the Canadian Mortgage and Housing Corporation (CMHC) historical records showing the median rental price in the Capital Regional District (CRD) from October 2011 through to October 2021 (the latest available published data), this shows that average rental prices have increased by 4.97% on average over the last ten years (source).

    To compare this to the latest CPI inflation information, we see that over the last ten years the rental accommodation aspect of CPI inflation for the CRD has only increased by an average of 1.92% (source).

    So on one hand, we have the CMHC saying that rents have increased by 4.97% annually (on average), while we have Statistics Canada through the CPI saying that rents have only increased by 1.92% annually. Where does this large discrepancy come from? 

    While these two values are computed through different surveys, and over slightly different time periods, it is easy to presume that as both surveys sample from the same population, we should have approximately the same values given the large sample size - that is to say, sampling error does not explain this difference. 

    What does then? Partly it is in how Statistics Canada and all OECD countries compute the CPI. By definition, the CPI is measuring the change in the price of a fixed basket of goods. For some goods, this is not problematic. IE. The price of a litre of milk in 2011 was $X, then in 2021 the price of litre of milk is now $Y - in this case, milk is milk and has not significantly changed over the last ten years.

    But what about when measuring expenditure on other items? Cars, Computers, Cell Phones, Housing? All of these goods have had quality increases over the last decade (a 2021 computer is not the same as a 2011 computer!) As a result, Stats Canada needs to recognize that quality has increased, and thus needs to determine what would be the change in price for a constant quality (fixed basket) rather than the change in price due to the fact that it is a fundamentally new good being sold (again, it would be tough to argue that a 2021 computer is the same good as a 2011 computer). 

    Statistics Canada does this by using a matched-model method to measure pure price changes. That is, attempting to determine what the price of a good would be if we could somehow keep the quality constant.

    While the idea behind this fundamentally makes sense and is necessary - there are some major problems. Often as quality increases, the consumer no longer has the option to obtain the cheaper, original-quality option. For example, as cell phone speed, and features drastically increase each year, you are stuck paying for these features even if you do not want/need them because there are few if any phones on the market that do not include these new improved features. The same can be said for housing or vehicles. In fact, if features (quality) increase substantially while price only increases marginally, this matched-model method may actually report that the price for this good has decreased from year to year! 

    This becomes exceptionally problematic if the consumer does not actually differentiate based on quality. With respect to housing, what if the consumer is primarily concerned with access to shelter rather than access to different qualities of shelter. 

    If this is the case, then shelter becomes homogenous irrespective of quality - That is to say that the potential consumer does not significantly see a difference between low-quality shelter and high-quality shelter. Given the current tightness of the rental (and housing) market, this makes sense - and we would expect to witness similar market prices irrespective of quality. 

    If we take the year built to be a proxy of quality (IE, newer built homes have newer better quality features) we could test this hypothesis by comparing the two possible outcomes:

1. If we witness little if any price difference based on year built, then the consumer primarily cares about the availability of shelter, irrespective of quality. 
2. If we witness newer places renting for higher amounts, then consumers value quality and thus are willing to pay a premium to access higher quality shelter. (If this is the case, then we should be accounting for this change in quality when computing inflation!)

    Likely, we will witness a bit of both happening, so the real question is where are we sitting today Vs. where were we sitting in the past? Well, we find the following (Source)

    How do we interpret the above table? Initially, we find a large spread between old builds and new builds, this would signify that in 2011, there is a desire for quality - renters were willing to pay more for a quality (newer) unit over a lower quality (older) unit. 

    As we move forward to today (2021) we witness that this spread has flattened out. in 2011 the maximum rental price was 43% higher than the minimum, while in 2021 the maximum was only 9.7% higher.  

    This is signifying that renters are caring less about quality than they care about access to units, thus resulting in a reduction in the quality premium. That is to say, while StatsCan, through the CPI, still discounts higher rents to account for increased quality - the renters are not caring about the quality so much as they are caring about access to shelter.

    To summarize, CPI Inflation says that the cost of rental accommodation has only increased by 1.97%  Vs CMHC's reported 4.97%. The reason for the significantly lower CPI inflation increase is due to the fact that there has (on average) been an increase in the quality of rented accommodation. To account for this increase in quality, the price increase must take the quality increase into account in order to compare "apples to apples". This "apples to apples" comparison yields only a 1.97% increase in rental prices over the last ten years. 

    While this method of comparison is preferred to compute changes in prices from an economic and policymaker standpoint, this is problematic when these same metrics are used to compute changes in the cost of living as they will often under-estimate the true change in cost - this is especially true when the consumer does not have the option (or ability) to continue to choose the lower (original) quality option. 

    The crux of the argument is to use caution when interpreting CPI inflation as there are many assumptions that go into these calculations, and the recently reported annual inflation rate of 6.7% (source) may not be telling you what you think it is. 

    Any comments or questions please feel free to message me or comment below.