Canadian housing supply plays a role in home price growth, but doesn’t explain all of it. The Bank of Canada (BoC) published a paper on Canadian Housing Supply Elasticities. In it the researchers explain supply plays a big role, but not to the extent we’ve seen. Over the short-term, it fails to explain the extreme recent price movements. I’m guessing the term they’re looking for, but could never use, is a bubble.
Housing Supply Elasticity
The elasticity of supply is the responsiveness of the supply of goods and services to price change. If a good is considered elastic, it means it responds very easily to prices. Elastic goods are considered luxuries, since their consumption can be tapered. If you can taper consumption based on price, in most cases, you didn’t need it in the first place. Supply is considered at 1.0 or higher, with higher ratios meaning it’s more elastic.
When goods are inelastic, it means there’s little change in consumption due to price. These are goods often considered necessities, such as prescription drugs. Higher prices don’t mean a consumer will opt for less, until they run out of money. Supply is inelastic below 1.0, with lower ratios meaning a market is less responsive.
Housing supply elasticity is a similar concept, applied to residential real estate. An elastic market would be a place that sees fewer people moving to a region as it becomes more expensive. Being there is more of a luxury than a necessity. Think of a cottage in Muskoka.
Inelastic markets are where people “need” to be, due to things like employment. These would be cities like Vancouver, where people need to be for work. Higher prices don’t necessarily change the number of people living there… to a point. More elastic cities have a greater amount of housing available, relative to population.
Canadian Cities Are Fairly Elastic, With Higher Prices Tapering Demand
The BoC found Canada’s housing is elastic, with population growth responding to price. The median supply elasticity for census agglomerations (CA), urban area, is 2.2 across Canada. For Canada’s census metropolitan areas (CMAs), large urban areas, it was a lower 1.94 — but still elastic. The central bank found at the median, most people can take or leave their city across Canada.
Housing supply elasticity contributes to home prices, but not as much as most would guess. They estimate a 1% increase in home prices in the median city is associated to a 2.2% rise in supply. The researcher suggests this can also be read the other way too. “A 1 percent increase in housing demand leads to an increase in house prices in the median city of 0.45 percent,”
Canadian Real Estate Markets Are Just As Elastic As US Markets
Canadian real estate markets aren’t all that different from US real estate markets. The median US metropolitan area has an elasticity of 2.26, just a little over Canada. Major American cities like New York (0.63), and San Francisco (0.72) are considerably more elastic than Toronto (0.89), but more similar to Vancouver (0.63). Despite similar elasticity, prices are very different — with Canada nearly 40% more expensive.
Comparing Inelastic Vancouver Real Estate and Elastic Winnipeg
Home prices in inelastic cities rise faster than inelastic cities, but not as fast as we’ve seen. Vancouver and Winnipeg have an elasticity of 0.63 and 4.34, respectively. If both cities received a 1 percent increase in housing demand, prices are forecast to rise 1.57% and 0.23%, respectively. A significant gap, but not exactly reflective of what we’ve seen short-term in these markets.
The elasticity amplifies home price growth, which is visible over the long run. The BoC found cities below the median elasticity saw an average growth of 400% from 1990 to 2020. Over the same period, cities above the median elasticity increased 300%. Once again, a significant gap — but not quite the gap we’ve been seeing.
The BoC says, supply plays an important part in home price growth, but it doesn’t play all the parts. Over the long-run, this trend is much more apparent than it is in the short-term. “Despite the importance of housing supply elasticities, they alone cannot explain dynamics in this market, especially in the short run,” writes the researcher.
The BoC isn’t the first organization to say home prices aren’t entirely due to supply. The IMF estimates Canadian real estate markets need as much as a 29% correction to hit fair value. The US Federal Reserve has said there’s signs of price exuberance, which are premiums paid unrelated to supply. The CMHC failed to find a fundamental reason related to supply as early as 2018, despite a contrary narrative sometimes presented. As if that wasn’t enough, then there’s the Bank of Canada itself.
The Bank of Canada also recently updated its internal forecasting models to conclude credit impacts home prices. In the notes for the updates to their primary forecasting tool they state, “… the main innovation is that borrowers now contribute to overall housing demand, allowing mortgage debt and HELOCs to influence prices.”
But, I mean, it could be a supply issue. Who knows, right?
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