Ontario Housing: Why retaining housing prices will harm working people
The cost of living weighs heavily today for working people. A major component of the cost of living is housing affordability. Recently, this became a major problem in Ontario, for which a solution is urgently required. However, tackling the issue involves determining the ideal housing policy.
Any policy naturally produces winners and losers. This asymmetry is highlighted by public discourse on the topic. While lip-service is paid to the unaffordability of rents and the mounting difficulty of entering the housing market, the bulk of conversations in the media have emphasized the importance of retaining equity in homes. This narrative is concerned with ensuring existing homeowners can manage the financial burden of retirement. However, this perspective ignores the impact of such a policy on renters (including retirees who rent) and first-time home buyers.
The Figures:
Some background is needed to better appreciate where we stand. Canadian house prices in the 1990s rose at a rate of 3 to 5 % per year. However, after 2017 the rate of increase was 14%, and during COVID it was 20%. As a result, a $450,000 home in 2015 is now $850,000. At the 1990s pace of 4%, it would be worth about $550,000.
The second component to affordability is wages. Ontario’s gross median household income has increased at about 1.8 percent annually, which falls short of the 2 percent average inflation rate during the same time period.
The ratio of house prices to incomes is also informative: in the early 1990s homes were about 3 to 4 times the median household income. Today, Ontario sits at 7 times income, and Toronto reaches 10–12 times.
For perspective, most financial advisors suggest a home’s value should be no more than 3 or 4 times one’s gross household income. Furthermore, Canadian banks rarely provide mortgages above 5 times a household’s income.
Stakeholders & Cultural Framing
Public discourse tells us retirees will be unable to retire unless their homes retain post-COVID values. While concern for retirees is honourable, this focus obfuscates the debate by ignoring renters and first-time buyers. It also produces a sense of entitlement amongst retiring homeowners that their retirement will be protected by a societal push to retain high housing prices
Assume it is true that a substantial number of retirees would be unable to retire if house prices fell back down to a ratio of 4 times income. The potential causes of the inability to retire would be: 1) the house being purchased for 3–4x income was too expensive, 2) reckless spending and lack of frugality, or 3) a mixture. Government would have to accept that it would have to protect groups falling under all three categories. It would also have to consider how to structure future policy.
However, if this were the case, this system could not sustain itself: if houses bought at 3 or 4 times income left a generation unable to retire, then a house that is 7 times income must be impossible to retire on. The current generation of first-time buyers would inevitably need to be subsidized in future by later generations. This method merely kicks the proverbial can down the road, during which the size of the shortfall increases disproportionately per generation. The result is reminiscent of a Ponzi scheme, where each successive group purchases an asset at a higher price, with the expectation of the price further increasing at the next sale. However, at some point, one group is left “holding the bag” – i.e. they are the chumps who cannot re-sell their overpriced asset to anyone else.
To illustrate, consider an example where a retiring couple requires $750,000 to retire, but their home is only worth $500,000. After the pandemic, their home value rises to $750,000. To retain the post-pandemic value of $750k, the extra $250,000 has to somehow come from the rest of society. (As there is no free lunch in economics, the value must be funded by someone else.) This amount comes directly or indirectly from activity in the same or comparable housing market, by purchasers of homes and renters. For example, when a comparable home is bought for $750,000, the market price is confirmed. Similarly, if a renter leases a $750,000 home and pays rent as if it is worth $750,000 (not $500,000), this further confirms the market price. Naturally, paying rent on the value of such a high home impoverishes renters, whereas a first-time buyer purchasing such a home will not realize their financial situation until years down the road.
There are a limited number of buyers for an objectively over-priced home. Many purchasers would be non-first-time buyers who utilize equity in their own over-inflated home to fund the majority or entirety of the purchase, and use cash for the difference. This advantage leaves first-time home buyers in a difficult situation: they need to use their incomes to make up the difference, which is a tall order. For a first-time buyer to invest in the housing market at $750,000, they would need a strong reason for believing the home will appreciate adequately to justify the investment. Our government’s stance of retaining housing prices appears to provide this strong reason.
If the first-time buyer were to purchase at $750,000 and the home were to appreciate even at a modest 4 percent per year - which matches the 1990s rate of increase - the home would appreciate to about $1.6 million after 30 years. By that same year, the median household income would only reach $150,000–$180,000 (assuming a continued ~2% growth rate for incomes). This would result in a price-to-income ratio of 9 or 10 times across the province. This absolutely unsustainable outcome would be caused by only a modest 4% rate of growth in the home’s price. Investors in real estate during COVID expected significantly higher returns than 4%. If the expected higher rate of return did occur, very soon homes would be worth well over a 10x ratio, leaving them out of reach for all but the most wealthy in our society.
The alternative is a growth rate lower than 4%. This would leave first-time buyers ‘holding the bag’: in exchange for wiping out their savings and over-leveraging themselves to save the retiree generation, these new buyers will be rewarded by owning an asset that rises in value at half the rate of the stock market.
Current Policy & A Better Solution
The cost to society of high housing prices – whether in the form of high rents or high costs to enter the housing market – is a form of indirect taxation imposed on non-owners. This is an indirect transfer of wealth to home-owners. Political maneuvering is not necessary to impose this tax, since it exists by default due to government inaction and the structure of real estate (which involves determining the market value of a home by pointing to individual sales and individual rents paid). The correct solution is for our society to assist retirees by actively imposing a higher tax on high income-earners, by utilizing the progressive tax rate system, rather than transferring wealth indirectly from renters and first-time home-buyers.
Of course, a larger problem with any sort of redistribution is that it does not increase the size of the economic pie, but merely shifts portions of the same pie around. Maintaining high housing prices – no matter who funds it – does not generate wealth. In fact, it removes wealth from other sectors of society, such as Main Street shops, which rely on locals having ample discretionary spending.
Barring a substantial increase of efficiency or resources in the Canadian economy, the only viable solution from this position is to progressively increase taxation on wealthy individuals and corporations, while aggressively building housing to alleviate the suffering of renters and first-time buyers. This will resolve the retirement issue without placing further burdens on the working class.