The superficial appeal of the 'population growth drives Canadian house price' argument: Does it hold water?
JULY 08, 2011
It's amazing to me how often I hear this argument. If you take a few minutes and read the comments posted on, for example, the Globe and Mail website every time there is an article about house prices in Canada, you won't have to read long before you find someone advancing an opinion along the following lines:
"House prices in Canada have been rising because of rising population. Population will keep rising, therefore house prices will keep rising."
There is a superficial appeal to the argument. It would seem at first glance to make perfect sense. Rising population creates demand for housing. We aren't making more land, therefore it must result in rising prices.
Let's first address what is true in this statement before discussing the massive holes in logic. Rising population can have a huge effect on house prices in cases where that demand cannot be met. It's a classic supply-demand equation, which we will discuss in a moment. This can be true in cities with restrictive land-use regulations, or in places where demand for a particular location (waterfront for example) outstrips available supply. This can result in house prices in those areas outpacing fundamentals that govern the housing market as a whole.
Some have made the argument that house prices in some of Canada's larger cities have been driven by this dynamic. The massive divergence between house price appreciation and income growth in Toronto and Vancouver are often explained in this way. Unfortunately it's not true. While certainly some of the growth can be attributed to this, particularly in high-demand areas where new product can not be brought to market to meet demand, but as a whole, it takes a back seat to other factors in driving house prices. Let's explore this concept a little more:
1) Restrictive land-use regulations and boom-bust cycles
The work of Demographia has argued very strongly that cities with restrictive land-use policies are prone to boom-bust cycles. In large part this is due to the wide-spread acceptance of this very story that rising population = perpetually rising prices. This creates the psychology that Mark Carney warned about in a recent speech in Vancouver:
...One cannot totally discount the possibility that some pockets of the Canadian housing market are taking on characteristics of financial asset markets, where expectations can dominate underlying forces of supply and demand. The risk is that expectations become extrapolative, prompting the classic market emotions of greed and fear—greed among speculators and investors—and fear among households that getting a foot on the property ladder is a now-or-never proposition.
No one explains this concept better than Australian economist Leith Van Onselen who has created the following graphs depicting house prices in US cities with restrictive and responsive land-use regulations:
Hard to miss the boom-bust nature of many of these American cities. And by the way, in addition to classifying Toronto, Vancouver, and Montreal as severely unaffordable, Demographia also notes that all three cities have more restrictive land-use regulations:
So we can conclude that if in fact it is the restrictive nature of land-use regulation in these cities that is keeping the construction industry from bringing supply to market fast enough to satiate demand, there is still reason for some concern.
However, although restrictive land-use regulation could create boom-bust cycles in these cities, I'm actually far from convinced that it has. In fact, the whole notion that population growth has been the primary driver of house prices increases strikes me as far-fetched. This brings me to point #2.
2) The 'population growth drives house price increase' argument entirely ignores the role of supply
Here is the massive fallacy of the argument. As noted above, house prices would be expected to experience strong growth when demand outstrips supply. But that argument cuts both ways; House prices should experience weak growth when supply outpaces demand.
It is supply and demand, and anyone who blindly accepts the 'population growth = perpetually rising house values' argument is accepting an idiom that turns a blind eye to an entire half of the supply/demand equation. Let's not do that!
As Don Campbell would say, let's do some meme-busting research. Let's start with some facts that have already been discussed here before: House prices and population growth, have an exceptionally weak correlation:
As do house prices and growth in immigration:
In fact, we don't need to delve into mathematical correlation to see that the relationship is pretty weak. Here we see house prices, population, and total immigration all set to 100 in 1980. There is no pattern whatsoever:
The bottom line is that Canada's growth rate has been remarkably boring over the past several decades. One would expect that if population growth has driven the past decade of exceptional house price gains, we would see a spike in population growth. Not so much:
And yet we are led to believe that this boom in population has led to this:
Clearly a weak argument. But we're not done yet.
Let's revisit a key concept: If demand outstrips supply, as the 'population growth = perpetual house price increase' argument holds, and if this is leading to house price increases, then the opposite must also be true. Let's see the data on this one.
To measure the accuracy of this statement, I have obtained household formation data from the Conference Board of Canada. I have compared it to housing starts from CMHC. Household formation is simply an estimate of the number of households that require new homes. Housing starts are the number of new homes that have started construction. If the argument holds water, we should expect that during times where housing starts (supply) exceed household formation (demand), there should be downward price pressure, while periods where household formation (demand) exceeds housing starts (supply), prices should experience stronger gains. But is it true? Let's look at Canada as a whole, and at the four most populated provinces.
BC
Alberta
Ontario
Quebec
I think we've seen enough to recognize that something else is at work here. The argument that population growth causes house prices to rise indefinitely misses the massive factor of supply. Let's face it: In the majority of Canadian cities, even the large CMAs, there is no shortage of building opportunities. This argument is wholly insufficient in explaining the unparalleled real house price increases of the past decade.
Here's your real culprit....and this baby's not sustainable:
Cheers,
Ben
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26 Comments
Great job, Ben! Fantastic Analysis! Thank you!
Emigration from Hong Kong to the greater Toronto area was robust in the early 1990s (around 10,000 people per year). These new Torontonians were fairly wealthy overall and were looking to establish residences in Toronto before the impending absorption of HK into the People's Republic of China.
Remind me what happened to Toronto RE prices in the early 1990s? :)
According to one of the charts above, between 1987 to 1999 house prices overall in Canada was relatively stable. Yes, you see a large spike in immigration during that period.
As for Toronto, local prices of a two story during the 90s was way below cost compared to 1987. A bubble popped. And we're gonna see another bubble pop, except this time, it maybe a slow deflate compared to the States.
The only thing that loose land restrictions get people is the ability to buy more house and pay less for the land. Part of the issue is that relaxing restrictions will usually be unpopular with incumbents. A family that wants a run-of-the-mill house, not caring too much for the location, can afford it more in a looser land planning regime than a stricter one; that's the only benefit I see and certainly worthy of discussion.
But the elephant in the room is too much debt. Crimp mortgage rules and prices will fall, regardless of land use restrictions, given there are few SIGNIFICANT impediments to building in any part of the country, despite Demographia's claims.
Ahhh yes land restrictions. The solution to that was for land developers to build smaller houses while providing more credit to new home buyers—so while nominal prices have risen, real value has declined.
Makes you wonder why Karen Kinsley (CMHC) has a close relationship with CHBA (Canadian Home Builders Association).
"there are few SIGNIFICANT impediments to building in any part of the country, despite Demographia's claims."
-does this statement hold true even for Vancouver? I see there is still a good amount of land available here for building; still, with the mountains and the border and the ocean and rivers (whose bridges are traffic bottleknecks) and the Agricultural Land Reserve all limiting growth, can it be shown that there is still enough land available to well serve demand for all types of housing? Any good studies on this?
Coming back from a visit to Europe recently I was struck by the difference. On a train into the cities or even towns in Europe you go from farmland to dense urban development instantly, with shops,restaurants and lots of people. Here you go for miles and miles through barren sprawl, both industrial and residential but no people. We are NOT "running out of land"! Take a drive sometime. There is a problem with suburban sprawl of transit unfriendly SFH with no sidewalks or shops, but that is a dead end with peak oil looming.
You may be right in some ultimate sense; but in the short to medium term, when land is already taken up by sprawl (though Vancouver sprawls considerably less than many other North American cities because of significant geographic constraints) and is controlled by associated zoning laws it is likely not readily available to serve other possible market demands. In the short term do we still have the available land to respond efficiently to market demands? Would we even know in a market shaped primarily by debt and outmigration of enriched house sellers, until that bubble burst?
There is always a Europhilic voice in these debates, but a lot of North Americans vote for "traditional" suburban housing and employers too often look for cheap suburban land. Consequently, a city like Burnaby has seen a mass exodus of the people who grew up here to various parts. Peak oil may well be a reality, but it remains to be proved and who knows what new tech will come into play, e.g. http://powerandcontrol.blogspot.com/2011/04/catching-wave.html
Very interesting to see the supply/demand dynamics graphs and is not what I expected
Noticed the correlation values on the graphs... Looking good. It helps your argument.
Nice debunking. Speaking of supply & demand, I wonder when this Boomer supply gusher starts to flood the market? http://i.imgur.com/KM3o6.jpg
Anyone know the original source of this graph? I'd be very interested in speaking with the author.
really interesting graph !!
According to this great Chart posted by Demitri, 2011 is the cross over year where we will have more sellers than buyers. The most amazing thing about all of this is that everywhere you look there are new homes being built. Do the home builders not read these statistics and understand the market they are in?
In my mind this is playing out in Calgary right now and it is exactly why prices have been drifting sideways and down. We simply have more supply than demand. And we are increasing the supply at a greater rate than the population is increasing. The City of Calgary demographic forecast shows the population is flat or shrinking in the 24 to 49 age cohort, and yet we are still building??????????????????????
I had considerable exposure to home builders and contractors and I have removed myself from the investment.
However bad a housing correction may be in the short term, lowering the cost of housing is the best way to address the demographic problem in the long term. Families need space and it needs to be affordable. Immigrants want the Canadian lifestyle and more families will move here if it is affordable. The real problem is providing employment. Too many older people and young families have too much debt due to the housing bubble already. These people need jobs but they can not spend. That is a mess.
Ben, I am relatively new new on you blog but I certainly appreciate a breath of documented reason in a sea of dellusional expectations.
Thank you for your great work!
Hi Ben,
Not sure if it was intentional or not but the photo you chose for this article is in fact the mac daddy bubbliest place on the face of the earth.... Dubai. Current values are off 70% from their peak in 08 with no end in sight...
Yup, looks to be. Lived through that one, and the delusion continues. Prices are still trying to find bottom.
Perhaps off topic but according to this immigration lawyer, the new 700 immigration investor class quota (effective July 1st) was fulfilled in 1 hour.
http://alexanderatkinson.ca/2011/07/breaking-news-canadian-immigration-i...
Now who will buy all those lovely multimillion-cash-purchased properties or have foreign immigrants been trapped and about to be drowned in falling home prices? Things are about to get very interesting...
Perhaps the next generation of students would like to buy a house since the average student loan debt is already $22,000—amongst the age group of 25-35.
http://rabble.ca/blogs/bloggers/progressive-economics-forum/2011/06/redu...
The housing market can only go two ways—mass inflation or a major deflation.
I think you are seeing the last desperate attempt at mass inflation now:
http://www.theglobeandmail.com/report-on-business/economy/jobs/wages-lag...
I don't think you can get massive inflation when the majority has massive debts. Intuitively, it's the "no free lunch for everyone" rule of economics. On the ground, the cost of servicing debt is now a significant component of household budgets. If inflation were to rise, interest rates would rise and debtors would face hardship. If debtors were a minority and the creditors are spending, the economy could shrug this off. But if the debtors are also the spenders then you'll get a bust.
@rp1 Inflation is already rising and will continue to rise until interest rates front-run the inflation rate. Watch lectures by Prof. Roberto Rigobon of MIT as he explains the durations of inflation to take effect.
We've just begun.
This guy sums up the elephant in the room at about 5:30 of the video.
http://watch.bnn.ca/#clip495302
I love how she says "we know interest rates are going to go up", and he kind of looks at her with an, "are you sure about that?" face.
At 7:10sec "Do you do the financially smart thing; and not buy a house; for maybe a long time." I couldn't agree more.
Yet the one topic that nobody discusses much is the effect of inflation which is about to rear its ugly head by China CPI coming in at 6.4% this weekend. Better stock up at Walmart while prices are cheap.
http://i53.tinypic.com/15s94zb.png
And while all those who dismiss Gold & Silver as alternative investments, watch the metals markets go bananas tomorrow. Once realization begins that the global financial system is nothing more then a giant ponzi scheme, you'll understand why you've been seeing CASH FOR GOLD at every street corner and now in shopping malls.
I know you don't like doom scenarios discussed here Ben, but that is the reality that needs to be discussed. Read Adam Fergusson's book "When Money Dies" which explains what happens when governments lose control.
Remember that no fiat currency throughout history has ever lasted more then 40 years. The US dollar (fiat system) started in 1970, you do the rest of the math.
"I know you don't like doom scenarios discussed here Ben, but that is the reality that needs to be discussed."
It's not that I don't like it. I happen to find it quite interesting, though I'm not a believer myself. I think precious metals should be part of every person's portfolio, though I wouldn't advise blowing brains out on them.
I wasn't a believer as well until I started to peel away the layers of the problem—which is and has always been the issuance of government securities, CHMCs IMPP and elusive currency swaps by the BoC. These are all forms of money creation (aka money printing)
IMPP http://www.parl.gc.ca/Content/LOP/ResearchPublications/prb0856-e.htm
Government Bonds Outstanding http://i56.tinypic.com/24bvhnp.png
BoC Swaps - http://www.bankofcanada.ca/2011/06/notices/bank-canada-announces-extensi...
The neo-keynesian model that accounts for 70-80% of the textbook curriculum is a complete failure and has nothing to do with central banking. At some point one must ask why all the secrecy and when given a chance to challenge a central bank the response is always 'because we know better.' Our biggest challenge before fixing the problem is to accept that the policies and governance that got us here have failed.
Wake up.
Hi Ben,
While I agree in general with you about the current housing market situation, the potential supply/demand relationship, and the new housing investment and demographic(new immigrants, more specifically) move. But I have a question, regarding the purchase power factor. In the past decade, more affluent immigrants came to Canada, the demand to higher end residential properties pushed and lead the housing market moving higher and higher. Do you have solid information in this aspect, which will better illustrate the housing market?
Thanks for your great analysis,
Richard