But a remarkably powerful policy measure is sitting right under policymakers’ noses

What started in Vancouver, Canada’s scenic outpost in the west, has now enveloped Toronto. Housing affordability crises of historic proportions now plague both cities.

The warning signs were all there, even for casual observers. To their credit, certain mainstream media outlets saw this unfolding, and posted sentries to report back to central Canada – Kathy Tomlinson of the Globe and Mail comes to mind. But political leaders in the heart of Canada remained either unaware or craven and timid in their reaction. Worse, some political authorities from the “centre” tried to silence the obvious alarm bells ringing in Vancouver – insinuating in various ways that West Coasters were just a bunch of xenophobes or racists.¹

But the concerns of Vancouverites were not a figment of their imagination. They were all too real. A wave of capital from abroad, primarily from China, was entering the Vancouver real estate market and driving prices skywards. And so now Toronto has joined the housing bubble club, as Vancouver put up a flimsy shield only to see some of that foreign capital bounce off it and ricochet east – and toward Seattle and Victoria.

Naturally, this dramatic development has sparked a massive debate in Toronto. Thirty per cent price gains year over year are hard to ignore, and tend to concentrate the mind of policymakers. For Vancouverites, what is striking in the Toronto debate is how eerie the parallels are to what transpired out west. The same bad arguments are being tossed around, and the same predictable obfuscation has emerged from real estate industry representatives and their apologists in academia and partisan politics.²

To call what is happening in Toronto a “debate” is to mislead somewhat. Differing perspectives are offered up, but the idea that many in the debate are interested in a search for “the truth” is questionable. As in Vancouver, the industry line in Toronto is that only “supply, supply, supply” can solve the problem. This has been debunked countless times, but it shuffles along unperturbed.³ It is a classic “zombie idea,” as Paul Krugman would say. That’s because there is simply too much money at stake for powerful people to ever allow the idea to die.

Indeed, those espousing the supply-side position in the housing debate haven’t even attempted a careful rebuttal to the demand-side perspective, despite ample resources to enlist academic hired guns. For the most part, in the media debate at least, the “rebuttal” amounts simply to “argument by assertion and repetition.” The few attempts to advance a slightly more careful supply-side case amount to the claim that some supply-side issues exist in the two cities, which few deny.⁴ But the idea that demand-side factors are the dominant force at work, including a large role for foreign capital, has never been effectively challenged. Very simply, supply-side issues on their own cannot get you anywhere near an average house-price-to-income ratio of 11 or 12, where it now sits in both cities. A surge in demand – from abroad, or due to dodgy lending practices, or both – is needed. Properly understood, supply issues constitute a small fraction – no more than 15 to 25 per cent by my estimations – of the high relative prices seen in Toronto and Vancouver.

The interested or sceptical reader is encouraged to check out the critique of the supply view advanced more carefully elsewhere.⁵ But prima facie, we can dispense with the supply-side case. Prices are surging to record levels in several major cities around the developed world, particularly those on the Pacific coast, far outstripping local income gains. This has happened in the past few years, several years after interest rates plunged to near zero. The supply case asks you to believe that all these cities simultaneously ran into major supply issues by imposing new onerous regulations and running into land constraints at nearly the same time. This is highly implausible, especially when we have an obvious alternative explanation: a massive wave of capital leaving China, combined with record low interest rates.

Despite the transparent implausibility of the supply case, the charade of a debate continues, given the media’s continued inclination – in Toronto at least – to predominantly interview real estate representatives.

In this article I revisit and refresh the debate around “but, data!”, discuss the ethics of foreign ownership and claims of “xenophobia,” puncture the delusions of “free market” arguments and, finally, sum up some of the political developments in the past year and what they portend moving forward.

Dude, where’s my data?

The absurdity of the housing debate is perhaps nowhere more evident than in the question of “data” and foreign ownership.

There is very little good, government-collected data on the question of foreign ownership. No one disagrees on this point. This is to the discredit of federal and provincial authorities, who for years resisted gathering rigorous data, even though Mark Carney, then governor of the Bank of Canada, warned quite clearly in 2011 that the Vancouver real estate market was being affected by money from East Asia.

The fact that five or six years could pass without any effort to collect data is stunning and can’t help but stimulate a tinge of conspiratorial thinking. Perhaps for the first time in Canadian history, there was a protest for data collection in Vancouver in May 2015.

The events of the summer of 2016, a full year after that protest, might indicate why it took so long for governments to do their jobs. Within five weeks of gathering data on the question, as the evidence arrived, the British Columbia government was pressured to introduce a stiff foreign buyer tax. It’s hard to avoid the conclusion that governments failed to gather data because they didn’t want to do anything about the issue. Why collect data that might be embarrassing? This gets to the politics of the field, discussed below.

With limited data, those who had their eyes open often had to rely on anecdote. But inconveniently for the real estate lobby, the inferential, and no longer just anecdotal, case was growing stronger and stronger. The report I wrote last year on Vancouver, for instance, which made the case that foreign capital was playing a major role, did not rely on a single anecdote. All the data it presented were carefully gathered, some of them by Canadian governments. But the evidence had to be pieced together to get a clearer grasp of the issue – including by eliminating other alleged, but ultimately insufficient, causal contributors.

When the B.C. government finally collected data, then, it was no surprise that the amount of “foreign citizen buying,” about 13 per cent, in Vancouver was much more than the 3 to 5 per cent estimated by the real estate industry. Nor was it surprising that 90 per cent of the foreign buying was from China. This was predictable, based on the strong inferential case.

The inferential case has only grown stronger since last year. Figures 1 through 5 tell important elements of the main story.

Figure 1 shows the broad outline of the two-track Canadian housing market, where Toronto and Vancouver have been red-hot in recent years while cities in the rest of the country have seen modest price growth or even price declines. Indeed, except for their “adjacent” or “spillover” cities, Hamilton and Victoria, there aren’t major housing affordability issues outside of Toronto and Vancouver, despite record low interest rates everywhere – and an alleged Canada-wide culture of “house horniness.” Something unique is happening in Toronto and Vancouver. It is not primarily a “big city thing,” a “lots of immigrants thing” or a “hard to build thing” – if it were, Montreal would be red hot too.

What do Toronto and Vancouver have in common that is unique? Strong interest from buyers with access to substantial money abroad, at present principally from China.⁶ This is evident from surveys of elite Chinese citizens about preferred destinations of real estate investment, from the sordid history of the federal Business Immigration Program, and from patterns of real estate interest on Juwai, a website that caters to real estate buyers in China.⁷ In a 2014 survey, for example, Toronto was sixth and Vancouver third as destinations for international real estate buying for Chinese elites.

Unlike Canadian governments, organizations in Australia and the United States have gathered at least rudimentary data on foreign buying. Figure 2 shows the amount of money spent by citizens from China in the residential real estate markets of those two countries from 2011 to 2015.

There has been a near trebling of buying since 2013 or so, as money fled China. We have good data about broader capital flight from China, and it shows an escalating amount of money exiting the country in this period.⁸ The sums in figure 2 are substantial; Chinese citizens were by some margin the largest segment of foreign buyers in these two countries in recent years. In the United States, the buying is concentrated in California (32 per cent of all purchases), where the most unaffordable markets (San Francisco, Los Angeles, San Diego) just happen to be. In Australia, the buying is concentrated in Melbourne and Sydney, again by far the most expensive markets in the country.

There is little reason to think that Canada is any different. If anything, Canada might be a more enticing target, as I explain below, and a falling exchange rate since 2015 has helped that along. But some may remain unconvinced. If only there was some proxy for money arriving from China…

As luck would have it, the Vancouver airport keeps a record of the amount of undeclared money being seized. In 2013, $2.8 million was seized from Chinese citizens. In 2014, the figure was $4.3 million, and in 2015 it was $6.4 million.⁹ This pattern of 50 per cent year-over-year increases from 2013 to 2015 fits the pattern in figure 2 nearly exactly. Data from Canadian banks on the total amount of foreign currency and deposits also tell the same story – a sharp escalation from 2013 onward.¹⁰

Fine, money is arriving, says the sceptic, but do we have any evidence that it’s affecting housing markets? Here again we need to assemble the evidence in unorthodox ways. Figure 3 shows rates of investment or speculative buying of detached houses in Toronto from 2012 to 2016. These data were collected by John Pasalis and his team at Realosophy, a brokerage in Toronto.¹¹ They used Multiple Listing Service data – the realtor listings database – to see what proportion of properties in that segment were bought and then listed for rent on MLS within a year of purchase. This indicates buying for investment purposes. As Pasalis notes, the data systematically undercount the amount of investment buying, because investors may rent properties through services other than MLS, leave properties unoccupied or move into the new property and rent out their old home. On the basis of this logic, Pasalis estimates that the amount of investment/speculative buying is potentially double or triple the rate he calculates given his methodology.

The pattern revealed in figure 3 clearly aligns with the data from figure 2: relative stability from 2012 to 2013, a small jump in 2014 and a big jump in 2015 (and 2016). Moreover, the areas where the most investor buying is taking place are areas with large Chinese diasporas. On the other hand, Brampton, with a large South Asian diaspora, has been largely unaffected until recently. What we see with the data from Oshawa and other outlying areas (not shown) is a big jump in 2015 and 2016 as locals get on board and get into the speculative groove.

Doesn’t all of this happen because there’s a shortage of supply? No, or at least not as the supply-siders portray it. As I’ve documented elsewhere, housing completions have been strong in recent years, relative to population growth and otherwise.¹² Detached house building is down modestly, but not dramatically. What has happened instead, as figure 4 shows, is that sales have surged (solid line, left-side axis) as investor buying has emerged. This has sharply drawn down “inventory” (dash line, right-side axis) as new listings stay stable (dotted line, right-side axis). Consequently, the appearance of scarcity emerges.

There should be no confusion: a sharp increase in sales is a surge in demand. A low rate of active listings is, in this case, a product of surging (record) demand, not weak (built) supply. Yet you’ll never hear Ontario realtor representative Tim Hudak or any other industry apologist admit that. Their line is that all we need is “supply, supply, supply,” as if you can build enough homes for a population caught up in a real estate frenzy who want to buy second, third or fourth properties. Trying to satisfy speculative demand is lunacy.

The evidence in figure 3 is especially problematic for the supply-side case. Why did speculative buying and total sales suddenly pick up in 2014–15 after a few years of stability? The obvious explanation is that capital flight from China acted as a catalyst. Some supply-siders might claim that inadequate new housing fostered broad speculative activity. But there is little evidence of a supply shift that would do this, given the data on construction and new listings. And, if the problem is inadequate housing supply in Toronto, why would the speculative activity be so geographically varied? The supply-siders have no answer for this.

Figure 5 is a modified version of figure 4 for the Greater Vancouver market, this time using a 12-month rolling average technique to smooth out seasonal fluctuations (and using monthly, not yearly, sales totals). As in Toronto, the same surge in demand (dash line, right side) has drawn down inventory (solid line, left side) and created tight market conditions – which first drove prices up rapidly, and then stabilized prices as new listings began to fall in line with the sales decline in early 2017.

The data and the foreign buyer tax

It is important to make explicit what figure 5 means for how we interpret the present debate around the foreign buyer tax. First, a surge in demand due to capital flight from China led to rising prices. Second, the demand cooled leading up to and especially following the introduction of the foreign buyer tax in July 2016 – the same month as the inflection point in the monthly sales data.¹³ Third, inventory started to inch up – but then new listings fell in early 2017, so that it has remained largely constant. What this means is that the foreign buyer tax has sharply curtailed demand, yet since it did not set off a run for the exits – a sharp rise in new listings – prices haven’t fallen much because inventory is still so tight.

In summary, the foreign buyer tax was not enough to break speculative expectations. This should be no surprise. The foreign buyer tax doesn’t apply retroactively, and unless sellers think the tax is going to make the market fall off a cliff – which they don’t – they have no strong urge to rush their property onto the market. In fact, the provincial government has given inconsistent signals. It imposed the foreign buyer tax in July 2016, but in December it offered loans to first-time buyers and this January it created larger loopholes in the foreign buyer tax. There are indications that if the Liberals are reelected in the B.C. election on May 9, the provincial government will further prop up the market and potentially rescind the foreign buyer tax. These inconsistent signals provide an incentive to hold off listing, which is what we see in early 2017. A fall in new listings has kept the market tight, and so for the moment Vancouver prices remain stable, and in some segments are rising.

While both the B.C. and Ontario governments are now collecting data on foreign buyers, they inevitably present a misleading picture. The existing efforts rely mainly on asking buyers whether or not they are foreign citizens. However, the issue in Toronto and Vancouver is about the source of the money for purchases, not citizenship. “Foreign ownership” is ownership primarily on the basis of foreign income or wealth. Citizenship can be a useful proxy for that, but it is incomplete.

Foreign citizen buyers are only one way that foreign capital can arrive in a market: wealthy recent immigrants, long-time residents with continued sources of income overseas and proxy buyers are all alternative channels.¹⁴ So the current government data capture only a fraction of foreign capital flows – the idea that the current Vancouver market is almost all “local” after the foreign buyer tax is complete fiction.¹⁵ This is why the chief economist at CIBC, Benjamin Tal, recently estimated instead that over 25 per cent of the Toronto market, and over 35 per cent of the Vancouver market, was foreign money.¹⁶

This weakness in the data collection effort has long been known, but governments have gone ahead with this strategy anyway. What this has done, probably intentionally, is make foreign ownership seem much less prevalent than it really is. And apologists for foreign capital have been only too happy to play on the confusion – yet another indication that we are not having a sincere debate.

Moving forward, to get a clearer picture, governments simply need to compare declared incomes in the period preceding a house purchase, in terms of both the duration of reported income and its level, with the purchase price. Where there is a substantial mismatch, governments will be able to conclude, after appropriate qualifications, that outside wealth or income is at play. Damningly, this doesn’t even require data collection – all it requires is data communication between Canadian governments.

A recent report from Richard Wozny is telling in this respect. It documented that house prices and average incomes, when disaggregated to the municipal level, were in fact negatively related in Metro Vancouver; some of the municipalities with the lowest incomes had the highest house prices, and vice versa.¹⁷ This has generated stunning statistics: in Vancouver and West Vancouver, long known to be top destinations for foreign capital, the average ratio of detached house prices to household income in 2016 was 37 (!). In Richmond and Burnaby, middle-class suburban municipalities but also top destinations for foreign capital, these same figures were 28 and 23 respectively.

Read those figures again. And realize that a bank is unlikely to grant you a mortgage much more than five times your household income, even with record low interest rates.

Yet the “debate” shuffles along.

“Xenophobia” and the ethics of foreign ownership

Another constraint on honest discussion about Vancouver and Toronto real estate has been concern that to criticize foreign ownership is “xenophobic” or even racist. In Canadian society, these are potent charges.

There are undoubtedly xenophobes and racists who oppose foreign ownership, but that doesn’t mean all such concern is motivated by these sentiments. In fact, there are strong ethical grounds for being concerned with foreign ownership.

Foreign ownership of residential property entails two main ethical problems. The first is that foreign buyers have access to sources of wealth or income that locals do not. This means that locals are potentially put into disadvantageous competition with foreign money for property where they reside. The second is that those who own based on foreign income or wealth may not have paid the taxes that have made the property so valuable in the first place. Since public investments in physical infrastructure, social services and legal institutions are not primarily made through property taxes, the value uplift they provide to residential property is effectively given to such “foreign” owners for free. In the case of Toronto and Vancouver, this means that local taxpayers are in effect subsidizing millionaires.

This injustice also has a generational component. Those who already own, who often bought when there wasn’t competition from massive amounts of offshore money, will see equity gains, while younger generations must either deliver those (tax-free) equity windfalls through highly leveraged buying or else be shut out from an attractive source of wealth accumulation and personal stability.

One way of looking at the present situation is that policymakers have turned Canadian real estate, especially in the large cities, into a highly attractive global asset class. Canadian governments do not effectively enforce money laundering rules, we have relatively low property taxes (or “carrying costs”) and the enforcement of capital gains taxes on nonprincipal residences has been lax. Add to this the nearly free public services that we provide to wealthy migrants and their families, if they choose not to work, and it is no wonder that the country has seen an influx of foreign capital. Frankly, as a wealthy individual in a capricious authoritarian regime, you’d be foolish not to avail yourself of the Canadian red carpet offer.

Ultimately, the problem is that while this policy framework benefits the real estate industry and homeowner equity and boosts short-term debt-based economic growth, it generates highly unaffordable housing markets, precarious levels of private debt and tremendous intergenerational and class inequity.

To put it bluntly, in return for subsidizing wealthy foreign owners and fostering an intergenerational wealth transfer, we have ripped apart the meritocratic social contract. Among the primary determinants of personal wealth in Toronto and Vancouver today are your date of birth, whether your parents own (or owned) and whether you have siblings. Working hard, getting trained and playing by the rules doesn’t get you very far any more, absent a gift from parents. No wonder younger people are furious – wealth is being transferred to those who have already hit the equity jackpot, while debt and stress are transferred to them. Not by coincidence, Vancouver had the lowest level of reported life satisfaction among all Canadian urban areas in a recent survey. The current framework is terrible public policy, and socially toxic.

Since these younger people are the kids of those with rising equity, at least the transparent unfairness of the situation is apparent to many in the older generation too. That is why overwhelming majorities in the two cities – near 80 per cent or more – are in favour of curtailing or taxing foreign ownership in various ways.

I made this very case in the Globe and Mail in April 2017.¹⁸ The response from the real estate lobby was silence. There is no compelling ethical case to be made for the current policy framework. It is indefensible, so no one tries to defend it.

But to point all of this out is somehow to be xenophobic or racist. Never mind that the concern is with foreign money and its effects, not foreign people. Never mind that there are straightforward policies that can address the effects of foreign capital without targeting individuals who wish to come to Canada and join the labour market.¹⁹

The status quo will not work out well. Many young people are being pushed out of their childhood cities, or pressured into massive debt, while being called “xenophobes” for asking for sensible policy reform. Housing bubbles of historic proportions are emerging, foreshadowing deep economic crises. And public authorities are concealing data and failing to enforce basic regulations. What could go wrong? Who is guilty of ethical lapses?

Appeals to the “free market”

The final arrow in the quiver of the apologist’s case is the claim that we should just “let the free market do its thing.” This is remarkably misguided in several ways.

First, the housing market is already thoroughly regulated. Indeed, it may be the most regulated sector of the entire economy. From zoning rules to building regulations to property taxes to strata rules to social housing initiatives to tenancy law to capital gains law to mortgage regulations and insurance, there are hundreds if not thousands of regulations and policies that currently address the market and its operation. The idea that a few new regulations or taxes on foreign capital will take us from the realm of a “free market” to a “state-regulated market” is laughable.

Second, housing markets are regulated for very good reasons. Human beings often make poor decisions when it comes to debt and potentially speculative assets, especially when they endow those assets with deep meaning. And the decisions some make have clear externalities on others. If I build a condo tower next to your house, you might have some issues with a “free market” in housing.

In short, have we really forgotten about the American housing crash already? All Canadians are ultimately underwriting what is happening in Toronto and Vancouver. If those housing markets go bust, the cleanup costs will fall on all Canadians, including possibly bailing out the Canada Mortgage and Housing Corporation, which has implicit taxpayer backing. Asking for macroprudential policy is sensible, not statist.

Finally, much of the foreign money arriving in Toronto and Vancouver is from societies that are far from free markets. To talk about the “free market” in such a context is as ironic as it is meaningless.

The politics of housing insanity

Contemporary discussions among policymakers have been mostly about how to “calm” or stabilize housing markets in both cities. But a “calm” market at historically unaffordable levels is not an adequate long-term goal.

In part, politicians’ timidity is driven by their wariness about threatening the equity of baby boomers, the most powerful electoral bloc in Canadian society. Their timidity is also due to an understandable fear of causing a housing crash.

Yet this is precisely why policymakers should have never allowed the situation to get to this point. The most blame should be reserved for those who had the chance to tackle the issue earlier and did not. This includes politicians at all three levels of government, but especially provincial leaders, who had the most important and nimble levers of power to address the situation. That the Ontario government watched the Vancouver situation unfold and yet still took no action – nor collected data for almost a year – is particularly damning.²⁰

When the discussion does get around to restoring affordability, the common refrain is that the situation is “very complicated” and that “there are no silver bullets.” Pundits stroke their chins and say these things with an air of gravitas. To use another Krugmanism, this is the “very serious people” phenomenon.

Yet there is a remarkably powerful policy measure sitting right under the noses of policymakers: a property surtax that can be offset against income taxes paid, while exempting seniors with sustained Canada Pension Plan contribution records. What this would do, as I’ve explained elsewhere, is reconnect the housing market to the local labour market.²¹ No longer would real estate in these places be an easy, subsidized place to park money from abroad. As a result, the marginal buyers would once again be primarily local income earners. This would, in turn, affect speculative and “fear of missing out” behaviour, and rebalance the market as those who had bought on the basis of foreign income or wealth, but who have no interest in working in Canada or paying their fair share of taxes, listed their properties. The “supply shortage” would sort itself out in a hurry.

So far, politicians have not been willing to implement such a surtax.²² Incumbent governments are too tied to real estate industry donations, and their strategies of economic growth too dependent on the patently unfair policy framework of pampering foreign owners.

Think about that: Canadian governments are unwilling to introduce policies that would ensure that many wealthy homeowners paid their fair share of taxes. Significant parts of the economies of Toronto and Vancouver are premised on tax avoidance or evasion – and the dangerous debt leveraging that ensues. And yet these incumbent politicians brag about being solid economic managers, and people believe them. Remarkable.

None of this is written in stone. Policy can be changed. The surtax policy will not solve every housing affordability issue, but it will deal with a substantial part of it. It may just require new political leadership.

Absent a major policy change, housing affordability will have to wait on rising interest rates or some macroeconomic shock, such as the collapse of the epic housing bubble in China. Figure 6 shows (real) national land prices in China increasing at a compound annual rate of roughly 17 per cent over a period of 12 years – or 575 per cent in total real terms. Economic growth in China has been impressive over that span, but not enough to justify such price gains. Price-to-income ratios in the biggest Chinese cities are therefore more than double those in Toronto and Vancouver, by some estimates, and the country has an estimated 50 million vacant homes.²³

Leaving our fates to global forces is not a good strategy. Better to get our policy frameworks in order so that as foreign capital arrives in Canada, at least the benefits are shared more broadly, and housing markets regain some sanity.

Continue reading “Housing Price Lunacy Moves East” →

The housing situation in Metro Vancouver has reached a crisis point. In recent years the city has become one of the least affordable places to live in the developed world, and the crisis shows little sign of abating. The standard measure of housing affordability is a ratio of average house price to income of around 3 or lower. A ratio over 5 is considered “seriously unaffordable.” Vancouver currently sits at roughly 13.

This affordability crisis brings a number of obvious harms. Much of the city’s young generation is being pushed to live far away from their friends, family and work in search of homeownership. Others, lacking sufficient means, are being shut out of the real estate market altogether and are forced to pay sharply rising rental rates. Debt levels are surging dangerously for many first-time buyers. Communities are being weakened by empty or underused houses and condos. Entrepreneurs are having a hard time attracting or retaining talent. And the list goes on.

Little of this is lost on the region’s residents. A poll in June 2015 by Angus Reid documented the frustrations of Vancouverites in stark terms.¹ A strong majority of respondents – 79 per cent – said that high housing costs are hurting Metro Vancouver. Even among homeowners, supposedly the “lottery ticket winners,” 75 per cent said that real estate prices were unreasonably high. Meanwhile, 87 per cent are worried that the next generation won’t be able to afford a house in Vancouver. Astonishingly, 43 per cent of respondents, especially the young and educated, have “seriously considered” leaving the city because of high housing prices.

Nor are many Vancouverites confused about the sources of the crisis: 35 per cent believe that foreign ownership is the biggest factor in generating the crisis, while another 47 per cent believe foreign ownership is “one of a few major causes.” Fewer than 3 per cent believe that it is “not a factor.” As I will document, this interpretation of the crisis is largely accurate: foreign ownership and investment is far and away the most important driver of the housing affordability crisis.

If it is so obvious that something has gone wrong in the housing market, why haven’t the relevant governments stepped in to do anything? There are strong majorities in support of a host of policy measures to address the crisis. For example, In June 2015, 69 per cent supported a speculation tax on flipping and 79 per cent supported an extra property transfer tax on foreign buyers. Yet, to the intense frustration of many Vancouverites, both the federal and provincial governments have sat on their hands.

Part of the problem in this respect is that there continues to be at least some uncertainty about the causes of the crisis. Another issue is that there has been a misunderstanding about the nature of home equity gains, on the part of both citizens and policymakers. Lastly, there hasn’t existed a coherent and plausible policy plan that could address the crisis. I deal with these issues in what follows.

The distractions of the “bubble defenders”

A range of influential people have had an interest in deflecting attention from the role of foreign ownership in the crisis. The British Columbia government is highly dependent on the housing bubble for its budget balance and its remaining meagre popularity. Construction and real estate services constitute over a quarter of the provincial economy, and if they falter the government will feel the heat. People in these industries obviously have an interest in keeping the bubble rolling too, and so they have presented a range of “distractions” to convince people that all is well and that Vancouver’s housing prices are justified by “fundamentals.”

By putting these distractions to the empirical test we can see that all is indeed not well, and concerted policy action is needed. I deal with the main five distractions here: low interest rates, the “desirability” of Vancouver, a “strong local economy,” geographic constraints on development (or “limited land”) and restrictive zoning/regulations. I also touch on a distraction offered up from the left: weak investment in social housing.

DISTRACTION NO. 1 – LOW INTEREST RATES:

The starting point to understanding the causes of Vancouver’s housing affordability crisis is to see just how extreme the prices are, relative to local incomes. Figure 1 illustrates this for January 2016. It makes clear that Canada’s high housing prices are almost entirely driven by Toronto and Vancouver. For those who blame low interest rates, that’s a problem: the whole country has the same low interest and mortgage rates, yet most markets do not have high ratios of average house price to household income.

Low interest rates enable households to buy somewhat pricier homes, but they can’t account for the exceptionally high prices in Toronto and Vancouver. Something else is going on. These are the only two markets with major levels of foreign investment (see below) – suggesting that foreign money is enticing (or forcing) local buyers to stretch themselves financially to live in the neighbourhoods of their choice.

This affects not just the “high-end” neighbourhoods where that money is most prevalent. People who previously would have been able to buy in those neighbourhoods now take their purchasing power to “lower-end” areas and drive the prices up there. Thus foreign demand at the high end creates cascading price pressures throughout the urban region and drives up prices everywhere. In sum, low interest rates are mostly relevant to the extent that foreign investment creates these competitive dynamics between locals; absent that outside impetus, housing prices remain modest.

DISTRACTION NO. 2 – THE “DESIRABILITY” OF VANCOUVER:

There is little doubt that Vancouver is a beautiful city and has a lot going for it: it is safe, clean, stable, polite and so on. It is routinely ranked near the top of global lists of “livable cities.”

Somehow, though, that’s lost on other Canadians and Vancouverites themselves. Net in-migration from the rest of Canada has been essentially zero since 1990, while Vancouver residents had the lowest levels of life satisfaction among the country’s 33 census metropolitan areas (CMAs). In fact, almost all population growth in recent decades can be attributed to immigration, and Vancouver’s population growth is not particularly high. It’s middling among the biggest CMAs.

What that suggests is that Vancouver is a particular kind of “desirable”: it’s desirable for the wealthy and housing-secure. And indeed, it is a top destination for high net worth investors from abroad (see below). But this is not the kind of “desirable” that bubble defenders usually imply. Recognizing it for what it is points us right back to foreign demand pressures.

DISTRACTION NO. 3 – “STRONG” LOCAL ECONOMY:

While B.C. did have the highest growth rate in the country last year, that’s the effect of the housing bubble, not the cause. In a strong local economy, there would be high and rising local incomes. No such luck for Vancouverites. Vancouver consistently falls near the bottom of the major Canadian cities in terms of average or median incomes, and its income growth has been lacklustre this century. A somewhat similar pattern holds for unemployment, which is middling among the major cities.

(NOT A TOTAL) DISTRACTION NO. 4 – GEOGRAPHIC CONSTRAINTS ON DEVELOPMENT:

Here we come to the most plausible of the arguments made by bubble defenders. Vancouver is uniquely constrained by water and mountains in terms of developable land. As the city population expands, the feasibility of building yet more single-detached housing is limited. Indeed, the stock of single-detached housing in the region was stable between 1991 and 2011, and fell between 2001 and 2011 by about 9 per cent. There is a strong argument that the constraint on land available for individual detached housing has pushed up prices of this kind of housing. Essentially what the argument boils down to is that as the population increases in a given area and it can’t expand geographically, then the price of land will increase and this will push up housing prices. The question is by how much, or how much densification will mitigate the price pressures.

Price charts show a clear price surge for detached housing, alongside more modest price gains for condos or apartments. Condo/apartment supply has increased rapidly in the same period, more than compensating for the recent decline in detached housing. The growth in condo/apartment supply has kept the average population / housing unit rate steady or falling somewhat since 1996 (admittedly average unit size has decreased). This steadily expanding housing supply, in line with population growth, should take a fair bit of price pressure off single-detached housing. Condos are (imperfect) substitutes for detached houses. (People are trading “location for yards,” after all.)

Because very few Canadian cities have reached the required size to be strongly “pushed upwards,” we must look to data from the United States, where the research on land constraints and housing prices is more developed. When we do this, we find that limited land is indeed associated with higher housing prices, but according to various simple estimations it could only account for a fraction of the high housing prices we see in Vancouver.²

Figure 2 presents one such estimation. It compares house price / income ratios in 24 of the largest real estate markets in the United States with the share of “undevelopable land” within a 50-kilometre radius of the city centre. (Undevelopable land refers to bodies of water and slopes steep enough to be prohibitive for development – e.g. mountains).

The trendline shows a positive relationship between land constraints and housing prices, but (a) it is not nearly strong enough to explain the 13.2 price/income ratio in Vancouver (the “prediction” is around 7 if we consider Vancouver the most land-constrained city in North America); and (b) the strength of the link is driven largely by Los Angeles, San Diego and San Francisco. These cities have also seen large foreign investment in recent years (from China especially, and San Diego in an indirect way). If we look at the relationship between land constraints and housing prices in 2000, before large flows of foreign money, the “predicted” price-to-income ratio for Vancouver is under 5, even if we assume the highest degree of land constraint in North America.

Moreover, all of the economic models that predict price effects from limited land expect that incomes will be relatively high in these cities, as workers need to be compensated for their higher housing costs if they are not to move away, and businesses will then need to become more productive than the national average to stay afloat. As I have noted, Vancouver does not have relatively high incomes. This suggests that outside income, or foreign demand, has been required to create the “decoupling” of housing prices from local incomes, precisely what we have seen.

In sum, constrained land can generate higher housing prices, but not by nearly enough to explain Vancouver’s extreme prices, and that dynamic has required the importation of foreign demand to be sustained on a long-term basis.

DISTRACTION NO. 5 – BAD ZONING/ONEROUS REGULATION:

This line of argument is pushed most strongly by developers and their associated research representatives. In this view, we haven’t been able to develop sufficient housing supply because of policies such as the provincial Agricultural Land Reserve, which preserves agricultural land and impedes its rezoning as developable land. Yet new housing has kept up with population, on a population / housing unit basis.

What developers would apparently like is far fewer restrictions on their ability to develop, in terms of both municipal regulations and ease of rezoning. There is something to this convenient view, since such regulations can weaken the “housing supply elasticity” in a city – that is, they make it more costly to develop new housing and thus put upward pressure on prices. The question again is the magnitude of the effect. And here we must turn once more to the U.S. literature.

In Albert Saiz’s paper on “undevelopable land,” the housing supply elasticity for different cities was estimated by combining estimates of land constraints and regulations / zoning restrictions.³ Without delving too far into the paper’s findings, the main conclusion is that even the highest housing supply elasticity of all the major American cities could not nearly explain the housing prices we see in Vancouver. That’s in part because land constraints and zoning / construction regulations are correlated: it’s only when cities start to get “pushed upwards” in a serious way that citizens begin to press local politicians for the regulations that will protect their home values (think traffic, sight lines, etc.).

In sum, housing supply dynamics simply can’t get you to Vancouver’s extreme prices, even assuming some of the strictest constraints in North America.

DISTRACTION NO. 6 – WEAK INVESTMENT IN SOCIAL HOUSING:

This argument is popular on the political left because it supports a policy they have always favoured: social housing. If low investment in social housing was a big driver of the problem, we would expect more investment to correlate with lower prices. Do we see this? Not really. What evidence we do have suggests that there are no sharp differences in per capita social housing investment from province to province, and thus it is highly unlikely that the major cities have sharply different levels of social housing spending or investment.

There is a good case for increased social housing investment, if it’s done right. However, given relatively little social housing building across Canada, and not just in Vancouver, it seems highly doubtful that we can explain the city’s affordability crisis with reference to this factor.

The major cause: Foreign demand

So if we can’t account for Vancouver’s housing prices in these traditional ways, that leaves foreign demand as the most likely suspect to account for the large “unexplained” variance. While we have poor data on the matter, we can pinpoint the role of foreign demand by looking at the history of the Business Immigration Program, at studies of high-end buying in “decoupled” housing markets and at recent international capital movements.

The Business Immigration Program (BIP) began in 1978 with an “entrepreneurial stream” that encouraged high net worth individuals to migrate to Canada and set up businesses.⁴ In 1986, though, another stream was added to the program: the “investor stream.” After a few tweaks, the investor stream basically required applicants to front the Canadian government a five-year, interest-free loan of $400,000 and have a net worth of at least $800,000. The proceeds were then distributed to the participating provinces on the basis of their admission rates. In 2010, these sums were doubled to $800,000 and $1.6 million respectively. In return, these migrants would receive permanent residency – in essence, “cash for citizenship.”

The investor stream was gradually expanded over the years and by 2011 it constituted 89 per cent of all BIP entrants. Two things need to be said: (a) the program failed in terms of its stated ambitions, and (b) the scale of the migration (wealth and human) to Vancouver was substantial, and consisted almost entirely of investors from China.

To the first point, the hope was that investor stream applicants would engage in business activities once they arrived in Canada. However, the vast majority did not do so, as indicated by very weak income tax returns, even 10 years after admission. To the second point, David Ley estimates that roughly 200,000 migrants arrived in Vancouver through different streams of the BIP between 1980 and 2012, representing between 8 and 9 per cent of the regional population and 17 per cent of all population growth. On a per capita basis, Vancouver was by far the most important destination for such migrants in Canada.

About 80 per cent of the investor stream migrants have come from China. The nationality of these migrants is noted not because of any intention to “single them out.” Rather, it matters because, lacking good administrative data from Canadian governments, we simply must tie the evidence together in other ways, as I do below.

Andy Yan, an urban planner with Bing Thom Architects and also affiliated with Simon Fraser University and the University of British Columbia, has conducted the most important study of high-end buying and “decoupling.”⁵ Yan looked at 172 homes sold in three Westside neighbourhoods between August 2014 and February 2015. The average price was $3.1 million. Among the buyers, 66 per cent had non-Anglicized Chinese names, which suggests recent arrival. Among homes above $5 million, they constituted 88 per cent.

Other research, such as that by Dan Hiebert, backs this up in a longer-term perspective and finds that the number of houses purchased by new immigrants constituted a major share of housing sales, and new immigrants from China were especially prone to buy houses.⁶ Tellingly, other research finds that the housing spending of the recent immigrants from Asia was unconnected to their declared incomes, unlike the pattern of other Canadians and immigrants from other areas of the world – suggesting a significant “decoupling” of housing prices from local incomes as a result of the BIP.⁷

Looking at the unprecedented surge in Vancouver housing prices in the past year along with recent capital flows provides another piece of the puzzle. The price of a detached home in Metro Vancouver increased by 27 per cent, while prices for attached units and apartments/condos rose roughly 20 per cent.⁸ Some real estate representatives have tried to attribute this to strong job growth, population growth and low interest rates. Changes in these “fundamentals” are quite modest and can’t possibly explain the price surge, though.What can? Foreign money.

Two things point to this. First, in 2015 US$1 trillion left China seeking safety. Second, the Canadian exchange rate weakened against the major currencies, such as the U.S. dollar and the Chinese renminbi, making Vancouver a more attractive place to invest. We don’t know precisely how much of this money came to Vancouver, but we know Vancouver is a target market. The Hurun Report details the lifestyle and investment patterns of wealthy Chinese citizens. In the 2014 report, these people were surveyed to get a sense of where they most wanted to emigrate, and where they most wanted to buy real estate.⁹ Table 1 reports these preferences.

Using surveys of this kind with better data on the share of money invested in real estate (gathered from the United States, which keeps track of this stuff), three economists at the National Bank of Canada estimated that almost $13 billion was spent by Chinese investors in Vancouver in 2015 alone.¹⁰ This represents roughly one third of all sales volume in that year. This kind of influx of money would cause a price surge, and indeed that is what we have seen.

Furthermore, when we compare table 1 with the most unaffordable housing markets in the developed world, the correlation between preferred destination and high price/income ratios is strong.¹¹ In short, Vancouver is not alone in witnessing massive price pressures through foreign investment originating in China.

The influx of Chinese money into real estate abroad did not start in 2015, as the history of the BIP indicates. The preferred destination data refer to 2014, but the preferences were likely similar for several years prior. Vancouver’s historically high price/income ratio can then be understood in terms of a continuous wave of offshore money. In the last few years, Chinese General Secretary Xi Jinping has waged an aggressive anticorruption campaign, which has coincided with anxiety over the country’s financial institutions and an economic slowdown. This combination of events has triggered a massive acceleration in wealth leaving the country in the past year or so, and led to a concomitant surge in Vancouver housing prices.

Tackling the housing affordability crisis

There are four main policy solutions to tackle the crisis. The first is the most likely to have a significant impact, but the others are important supplements.

PROGRESSIVE PROPERTY SURTAX DEDUCTIBLE AGAINST INCOME TAX:

This policy proposal was developed first by my colleague at the School of Public Policy, Rhys Kesselman. It has a three-part structure. First, it has a threshold of $1 million; only the property value above that is taxed, and the annual surtax rate rises progressively: 1 per cent on the property value from $1 million to $2 million, 2 per cent from $2 million to $3 million, and 3 per cent on anything over $3 million. Second, income tax paid in recent years can offset any surtax levied. This means that if you are paying income tax, the surtax will almost certainly not apply. Third, people who are retired with strong CPP contribution records are exempt from the surtax, as are veterans. In addition, residents are given the option of deferring the surtax until the time the property is sold, which will make it possible for some who are not exempt to stay in their current homes.

This proposal has a number of strengths:

It would act as a significant deterrent to new inflows of foreign capital.

It catches foreign and laundered money, past and present, by taxing the owners of homes who could not have afforded them with Canadian (declared) incomes alone.

Given the exemption structure, there would be very few Canadians affected for whom we might feel uncomfortable.

In the short run at least, it would likely bring in major revenues.

It would be administratively simple.

It would help alter expectations about future demand pressures, weakening the urge to “jump in” even on financially risky terms.

SPECIFIC RESTRICTIONS ON FOREIGN OWNERSHIP:

Since the surtax may not have a large immediate effect, other policies to curtail foreign ownership might be implemented. There are many options out there.¹² Some countries impose a large tax on the sale of a property to a foreign buyer, while others limit such purchasers to “new builds” or to one property only. While such policies are widespread, they have not been particularly successful on their own. In combination with the surtax, though, they would likely have a significant effect.

BETTER MONITORING OF FOREIGN INVESTMENT AND MONEY LAUNDERING:

This was a no-brainer even before the Panama Papers. We need better monitoring of foreign investment and enforcement of money laundering rules. Few disagree with this in principle, but governments at the provincial and federal levels have been surprisingly slow to act.

Not only do we need policy innovation to improve monitoring, but those responsible also need sufficient resources and teeth. For example, the Canada Mortgage and Housing Corporation has consistently published its “estimates” of the number of foreign buyers, But since there is no legal requirement to disclose the owner’s status, the CMHC is dependent largely on self-reporting. This usually produces massive underestimates.

In terms of money laundering, the same issues have arisen. The Canada Revenue Agency, which is tasked with investigating tax evasion and questionable financial transactions, had its international division gutted by a cut of 262 auditors under the Harper government. As Kathy Tomlinson has put it, “All the legal experts and CRA insiders consulted by the Globe felt Canada needs to change its tax laws and the CRA needs more resources to enforce them, so that wealthy foreign investors pay their fair share.”¹³

AFFORDABLE HOUSING INITIATIVES:

While I have argued that this is not primarily a supply problem, there is no doubt that in the short term a lot of people with lesser means are being marginalized in the housing market, sometimes to devastating effect. For these people, the government needs to step in quickly and provide affordable rental units that meet a diverse array of needs, including for young families. This can happen both through the provision of improved rent subsidies for families below a certain income level and through the initiation of purpose-built rental units. This type of action is already underway, but it needs to be expanded and sped up.

The politics of housing bubbles

There are a couple of clear lessons from the past decade in terms of housing market politics. The first is that being in charge during a housing slump is extremely risky for any government, right or left. When the bubbles burst in Ireland, Spain, Britain, the United States and elsewhere, the national governments of the day lost power, whatever their partisan stripe. Unemployment rose, deficits expanded, austerity was often imposed – and citizens didn’t like it. They quickly turfed the incumbents.

In Canada the Harper government did not lose power after 2008, but that’s largely because the housing market never seriously corrected. Quite the contrary: after a brief blip, the Canadian housing market (and private debt levels) shot upwards from 2009 onwards, as figure 3 shows. After repeated federal attempts to cool the national market, most cities now face relatively affordable housing situations. The major exceptions of Toronto and Vancouver mean that the country is still precariously placed financially, however. High levels of private debt, or “leveraging,” now risk undermining the economy in a major way if interest rates rise or a global demand shock emerges.

If this is bad news for Prime Minister Trudeau, the precariousness is even more acute for B.C.’s Premier Clark. The B.C. economy is intimately tied to the housing boom. Construction and real estate services represent over a quarter of provincial GDP! And so the bubble defenders are out in full force, both in industry and in government. To this point, the provincial government has fully aligned itself, politically and financially, with the real estate sectors.¹⁴

This is the second lesson about housing market politics that we have learned. Inside players, with large vested interests, are willing to shovel massive amounts of money to political parties to keep the boom booming. Then, when the bubble bursts, others are forced to pick up the tab and indirectly bail these people out.

The fact that the boom is so clearly being driven by foreign money, a single resolvable issue, is deeply upsetting to many Vancouverites. Other factors have played partial roles in the drama but, as I have argued, they have largely been distractions. This is not complicated stuff, ultimately. Many younger Vancouverites are being driven out of their childhood city in search of homeownership. Others are stuck renting at high rates and saving little. And because the parents of these young Vancouverites see their children’s struggles first-hand, they don’t celebrate much when they see their (sharply higher) annual property assessment.

This is not a problem that is going away, absent government action. Either the anger will continue to build or a market-induced crash will cause major economic turbulence for the region. Given how shaky the Chinese economy – including the Hong Kong property market – looks these days, this latter situation may well play out. Regardless, major pain or anger is in store for many Vancouverites. It is best that governments tackle the crisis soon, before these things become even more destructive. Continue reading “Lunacy in Lotusland” →