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The Lauderdale Paradox, And Artificial Scarcity In Canadian Real Estate

The Lauderdale Paradox, And Artificial Scarcity In Canadian Real Estate

The value of Canadian real estate has been debated for some time. Those that benefit from ownership, often say “fundamental value” is sending prices higher. Further adding that the increase of home prices, results in an increase of wealth for the country. Housing activists say that real estate has become highly commoditized. They argue, escalating home prices result in decreasing wealth for the public. These two opinions are very different from each other, but are both correct. At least according to a 200 year old puzzle, known as the Lauderdale Paradox.

Oh Yeah, Lauderdale… The Inventor of Spring Break, Right?

Not quite. James Maitland, a.k.a. the 8th Earl of Lauderdale (1759-1839), was a Scottish nobleman. He spent a great deal of his personal time, observing money and wealth. History buffs know him as the guy that insulted world famous traitor Benedict Arnold, resulting in a bloodless duel. However, that’s not the most important thing he did.

The creation of the Lauderdale Paradox, tops his list of contributions to society. Despite being rarely discussed today, the paradox shaped classical economics. The greatest economists of the time, from David Ricardo to Karl Marx, were all influenced by his work. Don’t worry, it’s not a socialist thing. Or a capitalist thing for that matter. It’s a series of observations to help understand value.

The Lauderdale Paradox, A Lesson On Value and Scarcity

The Lauderdale Paradox isn’t quite a puzzle like we would think of today. Instead, it’s a series of observations, which you would apply to markets. Maitland speculated there is an inverse correlation between public wealth, and private wealth. He defines public wealth as “all that man desires that is useful or delightful to him.” You know, things like air, water, and Ricky Gervais. Private wealth is pretty much the things you classify as public wealth, but “which exists in a degree of scarcity.”

Scarcity is the keyword here. In order to for something to have value, people have to believe there is only a limited quantity. One of his clearest examples is water. By itself, there’s little financial value attached, despite the fact it’s necessary. If someone was able to hoard all of the water, they would be able to establish great wealth. Not a little wealth either, Swiss chocolate company amounts of wealth (okay, I added that last part). The increase of private wealth through water hoarding, diminishes that of public wealth.

Finding things to monopolize is hard, good thing you can create artificial scarcity. Maitland uses the example of tobacco planters in 1700s Virginia. The Assembly passed an act restricting each plantation owner to 6,000 plants per slave. Since it’s estimated at the turn of the century, each slave tended to 10,000 plants, the Assembly reduced supply by 40% overnight. Demand can’t shift that fast, so prices likely spiked. In addition, during years where tobacco crops were high, they would burn any excess yield. This ensured there was no oversupply.

Virginia’s easy, and abundant access to tobacco, should have made the public rich. Rich in access to sweet, cheap nicotine. However, the restrictions on supply lead to a premium placed on the tobacco. This produced greater value for the private owners of the tobacco plantations. At a cost to the public’s access to a crop that was readily available in the region.

When the restrictions on supply were no longer enough, they started burning inventory. Rather than seeing private wealth diminish, they literally set fire to the windfall. Now this is tobacco, and you’re millennials, so you don’t give a s**t. Think more broadly. What other assets have value that you’re beginning to question, and may have artificial restrictions, at the expense of public wealth?

Value & Scarcity In Canadian Real Estate

Real estate just happens to be something people require, and is scarce. Thus, it has value almost everywhere in the world. I can’t think of a single place where they’re giving away free land, and if you can, feel free to send me an email. Further scarcity is added in urbanized countries, since people need to be close to a major city in order to work. Add municipal controls, land restrictions, and things seem pretty scarce.

This is why Canadian real estate has been holding value so well. Most of the livable, tradeable stuff, is in urban centres and is fairly scarce. Those that owned, sold, and built real estate were able to create a solid amount of private wealth, but only by deteriorating public wealth. Typically this is balanced by an oversupply, that gives a breather for the local economy to catch up.

Source: CREA, Better Dwelling.

Looking at that chart, you’ll see we didn’t get the typical breather in the most recent up-cycle. Prices across Canada (not just in major markets), increased 69.31% from 2001 to 2008, one of the fastest rises in history. This was followed by a three year period of price stagnation, in real terms. From 2012 to 2017, Canadians saw prices rise another 39%, which is another massive upswing. Developers argue this is due to underbuilding, caused by supply constraints. Sounds reasonable, until you actually run the numbers. Then it looks more like they began burning supply.

The Great Canadian Real Estate Supply Burn

Let’s look at Toronto, the centre of the universe. It’s a place with huge immigration inflows, and a bustling economy. There’s a lot of reason to believe the narrative that the city has a scarce supply of housing, and it feels that way. From 2006 to 2011, the city added 188,450 new households. To contrast, the CMHC only tracked 160,195 new completions. Since more homes were formed than built, upward pressure on prices is expected. Much of the previously un-utilized housing was now being used, making vacancies more scarce.

Looking at the same numbers from 2011 to 2016, we actually see a very different trend. According to Statistics Canada, 146,200 homes formed. CMHC data shows 175,825 new completions occurred during that period. Almost 30,000 more homes were created than homes formed, adding to the housing supply. Despite this, pricing pressure actually increased, and inventory available became more scarce. The construction of extra supply had almost no impact on easing prices, and it wasn’t even sold for predatory increases. It just wasn’t available for some reason.

Foreign Buyers and Vacant Homes

Two interesting trends occurred right around this period – the rise of foreign buyers, and vacant homes. According to the CMHC, non-residents owned 2.7% of all homes in 2017, a 35% jump in ratio from 2014. From 2011 to 2015, the CMHC estimates 8.48% of new condos were sold to non-residents. From 2016 to 2017, that increased to 11.65% of new Toronto condos. Developers increased their offerings overseas, despite significant domestic demand. This is a process known as massification, and it’s a method employed by luxury brands to create artificial scarcity.

Source: Statistics Canada, CMHC. Better Dwelling.

Vacancy also appears to be a problem in Toronto, with non-regular occupancy growing with the “lack of inventory.” The 2011 Canadian Census showed that Toronto had 89,754 homes not regularly occupied, just a touch over 4.31% of all residential dwellings. By 2016, this number grew to 99,236 homes, or 4.43% of all dwellings. The rate actually scaled up, and grew larger than it was in 2011. This is despite the fact that the city reached record low inventory available for sale. Yes, homes are being kept empty, creating even more inventory pressure.

Canadian real estate, especially in urban hubs like Toronto, is valuable. There’s no denying that. It’s just unclear how much of the value is real vs artificial scarcity. Real estate in Canada has produced an enormous amount of private wealth, but at the cost of the public. Typically this balances itself out, as the public gets a resting phase in which to build up its social coffers. It didn’t this time, and instead artificial scarcity continued to push it without any resting phase. The questions that need to be answered is what happens when you push scarcity beyond its natural cycles? How much did the public suffer by an unnatural extension of the cycle? and how long does it take for the public to recover?

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29 Comments

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  • Depth386 1 year ago

    Interesting article but it does not address the discrepancy between the City of Toronto’s numbers and Statistics Canada’s numbers, CMHC’s numbers… Who is right? That is the question. The author neglected to explore this gulf between these different institutions/entities’ statistics and possible reasons or explanations. Until that’s addressed, some salt please.

    Disclosure: I’m not a RE agent. I’m an angry millenial who ended up buying in Hamilton, $15K above insurance re-build value with over 20% down.

    • Bluetheimpala 1 year ago

      But that’s the issue my friend… Transparency. From smoothing prices to reporting households to immigration numbers we have a lot of problems in our market which contribute to the darkness most of us live in. Read back a few months and you will find some answers as some of the discrepancies you note have been examined. BD isn’t a magic genie; you don’t get to make a wish. For a millennial your comment is peculiar but I will take it at face value.

    • Trader Jim 1 year ago

      What discrepancy? CMHC numbers are meant to be compared to Census numbers, and the government designed the regions around that. Since the two are compared for government use, it’s a fair for the author to use them to make a point. It’s how your tax dollars spends are determined.

      If you mean the vacancy numbers, the City of Toronto came up woth a smaller number than can StatsCan’s non-usual resident number, because the city of Toronto wasn’t clear about what they refer to as vacant. Homes that are full-time AirBnBs? Not vacant. But they aren’t occupied by the usual resident either, they’re illegal hotels.,

      The City of Toronto has a vested interest in making these numbers look lower, because it’s their job to attract new tax dollars. Don’t count on proper methodology to come out of them. Look to them using data points from people like the Toronto Board of Trade, which is designed to make Toronto look like a booming place to do business all of the time.

      It sucks, but you also have to take the City of Toronto’s points with a grain of salt as well.

    • question guy 1 year ago

      why angry? you forced you to buy anything?

  • Bluetheimpala 1 year ago

    The game of musical chairs always requires fewer chairs but not too few so it seems competitive and fun. I think we’ve gotten to the point where people are seeing a stack of chairs in the corner and wondering what the fuck is going on. When prices are increasing land banking is attractive as you are getting something for literally nothing. But it cannot go unabated;even in a low rate environment because there are fundamentals. Could we see increases this year? Yeah, definitely in some segments. Are the wheels falling off? That’s for you to decide. Tick tock.

  • Dennis 1 year ago

    In Toronto a lot of “land banked” properties are currently being dumped into the market. When I see them on MLS I pull the sales history and 90% on the time they were bought in the past 3 years. Everything bought in 2017 and 2016 will sell at loss up to 33%. Factoring a a 3% Land transfer tax and 3.5% +HST real estate commission.
    I have an extensive database of sales information.

    This is unraveling very quickly as speculators are seeking an exit strategy.
    The key now is patience. 12-18 months worth.

    • Bluetheimpala 1 year ago

      Thanks k’s Dennis! I get the impression things are moving a lot quicker than expected. I think we could see a meaningful correction within 6-12…somewhat of a crash. I’m observing massive pricing discrepancies within the same markets. More and more empty properties. Junk that looks like it was sat on. Brampton is like a microcosm of what will payout everywhere in my opinion;like watching ants. Very interesting!

    • Sergio 1 year ago

      The loss is actually already happening now in my neighborhood.

      Look at this house (you need to register to see a sold price) https://mongohouse.com/soldrecords/5aa0cea84df2c4c08403eb3f

      June 2012 sold for $0.77M
      October 2016 sold for $1.05M
      June 2017 sold for $1.20M
      March 2018 sold for $1.11M (!!!!)

      The last guy lost 90K not counting Land Transfer and property tax, closing costs (and if he was not a realtor he paid a commission as well).

      This is just an example, other houses are also dropping in price, the winter is coming this spring and summer

  • Lloyd 1 year ago

    I believe there are 3 villians and their unholy nexus to the sordid state of real estate in Canada
    – Government officials, local, provincial and federal
    – Realtors
    – Builders
    I am curious to know how many homes are owned by these Government officials, Realtors and builders.
    To put into perspective, it appears where real estate is concerned ” There is no one to police the police”

    • george 1 year ago

      former liberal BC finance minister mike de jong owns 8 properties and several condos. when he introduced the foreign tax in 2016 he made sure the tax was only applied to Vancouver area since his properties were not there…guess by how much they valued after the tax….

      • Lloyd 1 year ago

        They should jail the guy. Unfortunately for the common man in Canada it is the “Silence of the Lambs”

    • backwardsevolution 1 year ago

      Lloyd – I think you correct in your unholy alliance assumption. This is a very good investigative report from The Globe and Mail in 2016 (updated in 2017). It illustrates what is happening in the world of “assignments”, which are opaque and the money made is never taxed. Follow the money.

      https://www.theglobeandmail.com/news/investigations/the-real-estate-technique-fuelling-vancouvers-housing-market/article28634868/

      Government officials know what is going on, but look the other way. They are often heavily involved in real estate as well.

      You are correct: there is no one to police the police. A recipe to print money.

  • NJ 1 year ago

    Skipping the natural cycle that author had talked about should eventually result in even more deep sh*t. RE hoarders burning local wealth to non residents offshore, by not considering local demand are the real culprits and should be taxed heavily so the lost wealth will naturally turn in. So public got to choose the right leaders who could stand up for the real cause.

  • Willy 1 year ago

    I don’t know about Toronto or other Ontario towns but I know I was looking for properties in Hamilton between 2016-2017 and I still have all the automatic listings from that time so I can compare to today’s prices.
    So when I check the MLS listings today and compare similar houses aka typical houses and some of the listings are totally the same houses I saw at that time and what I notice is the listings prices today for those similar houses are the same as April 2017 prices and even higher. Are they getting sold and if yes are they selling at full listing price? I don’t know because I don’t have the auto listing anymore as I told the realtor I was not buying anymore and looking elsewhere in canada.

    • John 1 year ago

      Refer to housesigma.com for sold values.

      Create an account with your cell number or email to receive the sold prices.

      Listing value is not relevant. Last year everything sold above, this year everything is selling below. Note some exceptions apply.

    • Sergio 1 year ago

      Look at this house, Willy (you need to register to see a sold price) https://mongohouse.com/soldrecords/5aa0cea84df2c4c08403eb3f

      June 2012 sold for $0.77M
      October 2016 sold for $1.05M
      June 2017 sold for $1.20M
      March 2018 sold for $1.11M (!!!!)

      The last guy lost 90K not counting Land Transfer and property tax, closing costs (and if he was not a realtor he paid a commission as well).

    • Bluetheimpala 1 year ago

      Oh willy you furry little rodent. Read this on an ‘insider newsletter’? Give it a rest

  • John 1 year ago

    I think oil is the best contemporary Lauderdale Paradox, and in a way also plays into RE with the low borrowing costs of today.

    OPEC creates a scarcity of something everyone has to buy or use. We can’t make out daily travels without it. For many years, OPEC would increase or decrease the oil available to market, ensuring steady price increases. This worked up until 2014 when US Shale oil production finally peaked and flooded the market with more oil than required.

    Did you ever think oil could go from $150USD to $30USD? I didn’t. It’s non-renewable and everyone needs it.

    Can/Will this happen in real estate? I think so. It’s just a matter of time before the supply catches up.

    • Bluetheimpala 1 year ago

      Good comparison John. It was only a few years ago that I read Oil is going to ‘sky rocket’ and basis was some drilling result, refining, middle east conflict, finite resource, blah, blah, blah…same thing happens with Gold, suddenly NOW is the time to buy…unfortunately our real estate is being viewed as a tradeable asset that the same sort of fear mongering can apply too but this isn’t a few grand in Future/Options or stock in oil companies but a multi-hundred thousand transaction that will shape a family for 10-30 years. Sad that no one over the last 5 years tried to put the brakes on this mess.

  • Matt 1 year ago

    Interesting article… Always curious how they determine household formation. I’d assume through tax returns. My gf and I moved in recently but file our taxes as single. I know many friends that do the same. Wonder if that affects the household formation stat, and if so how much higher the real number should be.

    • Raging Ranter 1 year ago

      They use Census and fill in the five year gaps with demographic trend analysis. Tax return data is a part of it, but only a part.

  • SAL 1 year ago

    Property sold before 5 years of the purchasing date taxable 50% of the asset value specially in Vancouver.
    Simple and real effective to stop domestic speculation.
    Stress test is just a painful punishment for the youngest or the first buyers.
    No fair for them to pay the greed of the others.

  • backwardsevolution 1 year ago

    Such a good article! Real estate, oil, diamonds, commodities (copper, aluminum, gold, et cetera) I remember reading a good article re how Goldman Sachs was hoarding aluminum in huge warehouses for years, allowing only a little out each day, until finally they were stopped. Last year I read about how the fruit growers create scarcity in order to keep prices up.

    We are subjected to artificial scarcity and monopolies, and yet all we hear about is the “free market”. What a laugh.

    • vnm 1 year ago

      We are all DEVO.
      Headlines now about how Montreal is the new luxury home investment opportunity.
      And guess what, apparently there is suddenly a shortage of supply.
      How did that happen?
      All those non-French speaking Vancouver and Toronto refugees fleeing to Montreal in the middle of winter?
      A big factor no one talks about is how the increasingly networked world has facilitated speculation and market exploitation.
      When a giant herd of cows moves, it’s not like any of the cows planned it.
      It’s more of an electro-chemical hive jump on the bandwagon lemming phenomena.
      Same with investor psychology.

      • Raging Ranter 1 year ago

        Ottawa too. Quotes in the media from prominent RE agents claiming “more than half my sales this month resulted from bidding wars”, and the media just uncritically regurgitating the propaganda.

        Yes, there were a few bidding wars no doubt, but more than half? No way.

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