Everyone in Canada will soon be able to afford a home. We just need investors to build more and rates to be cut, right? Anyone that can do basic math has probably been skeptical of that narrative and with good reason—even the people making those statements don’t believe it. Internal messages from the CMHC make very brief but important notes that challenge the exact narrative its leadership has been publicly spinning. More supply won’t bring down home prices, and lower rates won’t make them more affordable. Higher prices will make more supply feasible and lower rates will help boost prices.
CMHC Internal Chats Claim Higher Prices Will Improve Supply
The public is frequently told that housing is expensive because of a shortage. People will often say, “it’s simple supply and demand.” Messages shared between the agency’s communications staff and economists in 2021 show the circumstances are a little more complicated.
“Higher price level will improve development feasibility, so starts will remain elevated over the forecast horizon,” read a suggested point discussing a released forecast.
That’s right, an increase in supply is only viable with higher home prices. This has always been the case due to incentive and demand.
Incentive is straightforward—in a highly financialized housing market, it’s not about shelter. Development isn’t a charity, though some developers will masquerade as one for tax purposes. It’s a capital intensive, fairly high risk gamble. The wave of project failures that are currently happening, like the ones in Greater Toronto around 2018, resulted in significant losses for investors before any houses were actually delivered. A sufficient profit margin is required in order to attempt homebuilding or they might as well hit the Baccarat table.
Manageable input costs bring up the next important point—demand applies to all commodities, not just a finished product. A building boom means pressure on all inputs, especially for something we previously called the 3Ls—labor, land, and lumber.
That issue is further complicated by the fact that commodities are priced in US dollars and traded globally. Any decline in the currency means rising input costs for the developer, so a weak currency requires even higher prices. Global trade also means any sudden need for a commodity means bidding against other country’s competing for the same resources. Even if lumber comes from down the street, a buyer in another country may be willing to pay more, leading to higher costs or general shortages.
Central Banks Lower Rates To Raise Prices, Not Improve Affordabilty
Understanding how interest rates work also provides a little more context in this area. The Bank of Canada (BoC) is in charge of maintaining an ideal decay in the value of money (i.e. inflation). Their primary and most important tool to do this are interest rates.
When inflation is below the central bank target, interest rates are cut to stimulate borrowing. By stimulating borrowing, they’re allowing consumers to pull forward their purchases by using more of their future income for a purchase today.
The goal is to intentionally stimulate demand faster than supply, and drive the non-productive price growth better known as inflation. Easy to achieve since credit is made with a speech, but scaling a supply chain takes years.
To connect the issue more bluntly, excessively low rates stimulate excess demand to drive prices higher. This excess demand is compounded by the influence this has on the 3Ls, especially when the world does it all at the same time.
The public may not have heard this so bluntly, but the BIS made a similar statement. They attributed the recent surge in home prices to excessively low rates held too low for too long, not a sudden surge of population growth everywhere at the same time.
CMHC Attributes Higher Prices To Cheap Mortgages In Passing
Higher prices are often blamed on population growth, especially in Canada with its recent record surge since 2022. Home prices made a record move in January 2022, but 2021 was the lowest annual population growth for the country going back to at least the 1970s. That was also the year Canada was completing 18 homes per person the population grew by.
Source: CMHC.
How the heck did that happen? Considering how much the CMHC has stated that lower rates will help affordability, one would never assume their internal chats would contain a different answer.
“Higher prices, as a result of low mortgage rates, will…,” notes an agency staffer.
That might be an unusual take for a public used to hearing that lower rates will improve affordability. Heck, even the BoC has made that statement on multiple occasions. Strangely, that’s not how they explain the issue to professionals that actually understand credit.
In a presentation to financial professionals, leadership of the BoC presented a similar point. In 2021, they explained that low rates haven’t made housing more affordable over the past 30 years. It did the opposite—home prices climbed to absorb the excess credit capacity introduced by rate cuts. It didn’t improve affordability. It helped buyers to pay significantly more.
That’s just the BoC though—what do they know? Well, the US Federal Reserve also presented a study showing lower rates don’t improve affordability. Their key message was a reminder that affordability isn’t just the cost of credit, but also the quantity of credit. It seems obvious, but apparently it isn’t.
Canada needs more housing, especially with it’s forced population growth. Objectively, not everyone can afford them at these prices—it’s almost like they don’t exist. The forced state-backed subsidies to bailout developers also hasn’t helped with supply, but reinforced an inefficient cost that is having the inverse impact on new home building.
Yes, we know. Population growth, population growth, population growth. Consider the Greater Toronto region—the fastest growing major city in North America, building just a fraction of its estimated population growth. However since interest rates climbed, home and rental prices have stalled. Home sales have also stalled, and record inventory appeared—but more surprisingly, rental vacancies are surging, and are now higher than they were in 2019.
Which makes sense. If buyers can’t afford a home, it doesn’t matter if one or ten can’t afford it—no one is buying it. Either prices have to come down or more credit needs to be introduced to prop up inefficient prices. This is a credit issue more than a population issue.
Or maybe the CMHC’s internal messages are wrong, along with the BIS, Bank of Canada, and US Federal Reserve. Politicians might be right, and investors will continue to finance building homes until they lose money, then continue to lose even more just so people have the housing they need.
