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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