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opinion

Kean Birch is an associate professor in the department of geography at York University

I live in Toronto, and I rent. It was a deliberate choice when I first moved here in 2011, but now it’s not. I recently worked out that our family could buy a house valued at about $720,000 on our current rent: nothing close to the cost of a house on our street, currently selling for around double that. If we want to stay where we are – close to the subway, good schools and more – we can continue paying rent, or we can double our housing costs by buying in the neighbourhood. Buying would mean we’d be paying about 40 per cent to 50 per cent of our disposable income on housing, which is common in Toronto.

Now, we don’t want to spend that much on housing as it limits what else we can do. But my point is not to complain about our personal circumstances. Instead, it’s to highlight a gap in the housing affordability debate going on in Toronto right now – as well as the rest of the country. We saw an example of this debate during part one of The Globe and Mail’s National Housing Innovation Event Series, on Dec. 6. It showcased a series of speakers, including Evan Siddall, president of Canada Mortgage and Housing Corp., who started off arguing that the dream of housing ownership is unsustainable and that there’s a need for densification to reduce housing costs. Other speakers made similar points, including that increasing supply hasn’t solved anything. Contradictorily, most speakers also argued that increasing supply of the “missing middle” – of low-rise rental apartments – is a key solution to the problem.

This won’t solve housing affordability, however, for a relatively fundamental reason: Housing is an asset. What does this mean for housing affordability?

A couple of recent research notes coming out of the Bank of England highlight this issue. The authors – John Lewis and Fergus Cumming – say that housing has a dual quality: It provides “housing services” to its inhabitants and it’s an asset. You can buy those housing services using a mortgage (and not pay rent to someone), or you can rent them. Unlike other goods and services, you can’t store housing services – buying when cheap and saving to use later – so rent reflects current supply and demand in the market, but house prices entail another dynamic.

Since housing is also an asset, its “price is determined by the (net present discounted) future value of its annual yield” – to quote Mr. Lewis and Mr. Cumming. They note that because asset prices are determined by future yields, they rise and fall in response to the future returns on other assets, and are therefore especially responsive to real interest rates. Consequently, as interest rates fall, then asset prices will rise as investors move out of safer assets such as government bonds for more valuable future returns. The yield from the sale of housing services (i.e., rent) can stay the same over time (so no one is paying more rent) and house prices will still rise as interest rates fall since houses become a more attractive investment asset.

So, to simplify somewhat, a house on our street with an expected future return of $36,000 a year – our current rent – would mean that buyers should be willing to pay $360,000 for it when real interest rates are at 10 per cent, assuming a 10-year time period. But, when interest rates fall to 5 per cent, then buyers would value those same future returns more highly, paying double the price at $720,000; and at 2.5 per cent they’d pay $1.44-million. Rent doesn’t change, yet the price of a house does, and significantly. And, it’s important to remember, these numbers don’t include mortgage interest. Counterintuitively, this means as interest rates fall and remain low, it becomes more expensive and takes longer to buy a house. Research by the Bank of International Settlement supports this argument.

Putting this dynamic together with the massive injection of surplus capital that various central banks released into the global economic system through quantitative easing after the 2008 global financial crisis highlights the fundamental problem we’re facing when it comes to housing affordability. Until interest rates rise, house prices will stay high because housing represents an in-demand and relatively safe asset class. At the Housing Innovation Event, Cherise Burda from Ryerson University made this very point, saying that 90 per cent of downtown condos in Toronto are investment vehicles.

But – and here’s the problem – if interest rates are raised, then this will erode the value of housing assets: It’s an intractable policy choice in the current political climate. No one dares to threaten the status quo, which is why we end up with political parties pursuing policies to expand mortgage access even further and simply exacerbating the problem of housing affordability.

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