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In recent months, politicians have been speaking with increasing urgency about housing affordability in Canada. But it’s not clear that policy makers, or the broader public, understand what restoring affordability actually means in terms of dollars and cents, according to Charles St-Arnaud, chief economist at credit union hub Alberta Central.

In a report published last week, Mr. St-Arnaud crunched the numbers on the size of adjustments that would be needed to bring affordability, specifically for the home ownership segment of the market, back in line with historical trends in seven of Canada’s largest cities.

There’s no universal definition of affordability, but Mr. St-Arnaud looked at a handful of measures, including house prices relative to income, mortgage payments relative to income and required income to afford the average home. He compared the current numbers to the historical average since 1980, city-by-city.

The results are striking. At current interest rate levels, house prices across the country would need to decline by 40 per cent to restore affordability to its historical average. Alternatively, the average family income would need to rise by 66 per cent, or house prices would need to stagnate for more than 10 years, if incomes grew 4 per cent a year. The required adjustments are much larger in cities such as Toronto and Vancouver than in Calgary, Edmonton or Winnipeg.

Even if interest rates fall two percentage points to a more neutral level – something many economists foresee over the next few years as inflation normalizes and the Bank of Canada unwinds its restrictive monetary policy – house prices would need to fall by 26 per cent nationally, or incomes would need to grow by 36 per cent.

The Globe and Mail spoke to Mr. St-Arnaud about what it might mean to restore affordability, and the thorny political trade-offs this could entail.

How has housing affordability changed in recent years?

Housing affordability is not a new topic. We’ve been discussing issues, mainly in Toronto and Vancouver, since probably the early 2010s. It’s just that at the time, prices were high, but we had lower-than-average interest rates, which allowed people to buy more expensive houses but still keep the same mortgage payment.

Then over the past two years, interest rates have normalized quite sharply with the Bank of Canada fighting inflation, and that compounded the impact of those higher prices on affordability. Also, since the pandemic, we’ve seen a big increase in house prices. Part of it was people had money to buy, and the increased demand from immigration. All that just pushed us to the point where affordability in Canada in most markets is at its worst since the 1980s, and in Vancouver and Toronto, it’s at the worst ever.

The size of the adjustments you’re talking about, whether in home prices or incomes, is huge. Is it reasonable to expect we’re going to see changes of this magnitude? Or were you trying to make a broader point about affordability?

We hear about affordability. You have the Canada Mortgage and Housing Corporation saying we need to build 3.5 million units over the next decade. Okay, I agree, we need to increase supply. But I don’t think people really understand that building 3.5 million houses will have an impact on the market, it will have an impact on the price.

At best, prices are stagnating for almost a decade. Or at worse, we’ll see a big decline in prices. That’s great for people who are not in the market. But for someone who bought a house over the past five, six years, and probably overstretched themselves, their house is probably their only asset. Are they going to be on board with no gains for a decade? We talk about affordability, but I don’t think we have an idea of what it is concretely in real life.

You talk about three ways to restore affordability: House prices can fall; incomes can rise; or interest rates can decline. What’s most likely?

I think it depends on how bold we want to be. If we do it through price changes, you have a more rapid adjustment, but it probably has some more cost. So, for example, you need a 50-per-cent decline in Toronto in terms of house prices. If you have that happening very rapidly, how many homeowners suddenly have big financial consequences? And what are the ripple effects on other things? You can imagine suddenly banks are seeing the collateral on their loans dropping by 50 per cent. That has a lot of ramifications.

At the other end of the spectrum, if you just leave income doing the adjustment, you’re talking about having house prices stagnating for 18 years in Toronto. So, at the end of the day, you have to do a cost-benefit analysis. What are the costs of doing a more rapid adjustment through prices versus the cost of doing it too slow: People leaving those cities, it’s hard to attract people, it has impact on productivity. It’s almost like you need to balance those two.

Bank of Canada Governor Tiff Macklem has said several times in recent weeks that monetary policy can’t solve Canada’s housing affordability problem. What do you make of that argument?

It will ease the problem, but it doesn’t solve it. We still need a big adjustment. If we keep house prices and incomes where they are and we just vary interest rates, you would need negative interest rates in Toronto for the city to be affordable. How reasonable is that? And if you really want to drive interest rates down to support the housing market, house prices are not going to stay where they are. You’re going to create demand in a scenario where you already have supply shortages, so you’ll have just an explosion in prices.

Your report is mostly about home ownership. Where do renters fit in?

Both markets are linked completely. If housing is not affordable, people will rent more, pushing up rents. If rents are too unaffordable compared to a house, people move to houses. The problem is that they’re both moving in tandem right now, where everyone, renters and homebuyers, are both facing very high costs. Which is very different when you look in the mid-2010s: Ownership was getting less affordable, but rents were still okay.

What are the costs of not restoring affordability?

There’s the first-round impact: With a household having to spend an ever-greater share of its income on shelter costs, that reduces other types of spending elsewhere in the economy. There’s a big increase in debt levels, making you more vulnerable to shocks. There’s reduced flexibility in terms of the labour market: Are people willing to accept the job in Toronto, if they could have the same income in Calgary?

Then there are more social impacts, increasing inequalities between those who are homeowners and renters, because homeowners will see appreciating assets while renters don’t.

Your report asks: Will homeowners be willing to bear the cost of stagnating or falling home prices to restore affordability? What do you think the answer is?

I don’t think we have a good grasp of it. There was a survey done by Nanos last summer asking: Would you be okay if house prices went down? 70 per cent of people said, ‘Yes, I’ll be fine.’

But there were no details in terms of whether the answers were from homeowners versus non-homeowners. And what if we quantify that decline? If we were to say, ‘It’s a 5-per-cent decline,’ I’m sure the majority will be fine. But if you suddenly say, ‘Actually, 25-per-cent decline or 40-per-cent decline,’ people may have a very different answer.

The interview has been edited for length and clarity.

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