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.

Notes

¹Angus Reid Institute, Lotusland Blues: One-in-Five Metro Vancouverites Experience Extreme Housing & Traffic Pain; Most of Them Think of Leaving, June 18, 2015, retrieved here.

² This argument is spelled out clearly in my report (Vancouver’s Housing Affordability Crisis: Causes, Consequences and Solutions), especially in Appendix B.

³ Albert Saiz, “The Geographic Determinants of Housing Supply,” Quarterly Journal of Economics, Vol. 125, No. 3 (August 2010), pp. 1253–96.

⁴ What follows is largely drawn from the pathbreaking work of UBC Geography Professor David Ley. The Citizenship and Immigration Canada 2014 report on the program is also very useful (available at here). Finally, see Ian Young, “Study Reveals Awfulness of Canadian Investor Immigration; Income Tax Averages C$1,400 per Millionaire,” South China Morning Post, March 23, 2016.

⁵ You can access the study’s main findings here.

⁶ “Immigrants Help Drive the Vancouver Housing Market: Study,” Vancouver Sun, March 12, 2016.

⁷ See Markus Moos and Andrejs Skaburskis, “The Globalization of Urban Housing Markets: Immigration and Changing Housing Demand in Vancouver,” Urban Geography, Vol. 31, No. 6 (2010), pp. 724–49.

⁸ “Even Luxury Listings Don’t Last in Vancouver’s Hot Housing Market,” Toronto Globe and Mail, April 4, 2016; Real Estate Board of Greater Vancouver, “March Sets an All-Time Record,” April 4, 2016.

⁹ I thank Anjum Mutakabbir for drawing my attention to this document, available here.

¹⁰ “Study Likely to Fuel Debate on Foreign Home Buyers,” Toronto Globe and Mail, March 23, 2016.

¹¹ The Demographia studies on housing affordability are useful here. See them here.

¹² An excellent discussion of the various policy measures in place in different countries is found in Daniel Rossall Valentine, Solving the UK Housing Crisis: An Analysis of the Investment Demand Behind the UK’s Housing Affordability Crisis (London, England: The Bow Group, 2015), retrieved here.

¹³ “B.C. Pledges to Close Loophole that Allows Some Real Estate Investors to Dodge Taxes,” Toronto Globe and Mail, October 7, 2015.

¹⁴ See for example, Gary Mason, “Donor Lists Reveal B.C. Liberals Greed for Power,” Toronto Globe and Mail, April 5, 2016.