It seems that in recent years, more and more people are thinking of housing as an investment rather than as a place to live. This trend seems to have caused many countries to witness rising house prices, particularly in global cities. As figure 1 shows, house prices, as a multiple of median family income, have been quite high in the many global cities around the world.
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Figure 1
At the same time, in some of these countries the mortgage debt to income ratio has been on a general upward trajectory (see figure 2).
Figure 2
One explanation for the rising house prices and rising debt to income ratio is that, in the past decade, the cost of borrowing and the yields on safe assets (such as government bonds) have been quite low, making real estate a more attractive investment.
However, why is it that real estate prices increase quickly in some cities but not in others? How are these “hot” real estate markets different from other markets? If one looks at major Canadian cities, they see two things: 1) in the most expensive cities, the supply of housing is slow to respond to rising house prices (also known as low elasticity of housing supply), and 2) in the least affordable cities, households’ portfolios are geared more towards mortgages (see figure 3).
Figure 3
This is worrisome not just for home-ownership, but also for renting, as more households spend more than 30% of their gross income on housing costs in the most expensive cities (see figure 4).
Figure 4
It seems that the main driver of the above-mentioned outcomes is the slow response of the supply of housing in those global cities (as we saw in figure 3, the most expensive cities in Canada are also the ones where the supply responds the least – the lowest elasticity of housing starts). The slow response is likely an amalgamation of strict regulation at the city level, slow processing of construction permits, an inability to convince neighborhoods to allows the development of high-rises in their backyard, etc. From economics 101 we know that the slow response of the housing supply drives up house price growth rates and requires households to take on larger mortgage debts in order to afford a house. As well, since house prices are higher, rents rise because rents are normally around 3.5%-6% of the property value. So if the property value rises, rent should rise as well.
The latter may explain why we observe a larger fraction of the population spending more than 30% of their gross income on housing costs in the most expensive cities (again refer to figure 4). Furthermore, the large growth in house prices seems to create an expectation of future house price growth rates. This is demonstrated in figure 5 – in cities where house price growth rates are highest, homeowners care most about future house price appreciation. These expectations likely fuel additional mortgage debt, more rapid house price appreciation, less affordable housing, and put more households in rent-distress.
Figure 5
All of the above is related to the concept of “financialization of housing”: when households start viewing a home as an investment rather than simply a place to live. Since the issue seems to be exacerbated by slow supply responses, the solution lies with local municipalities and local residents being more willing to increase the supply in city centers. While this may be simple in theory, it is much more complex in practice. Perhaps you can weigh in and offer some ideas.
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*Graphs and data are courtesy of the Housing Finance, Policy and Research Group and Housing Market Indicators Group at CMHC.
*Disclaimer: This post was written by Shahar Rotberg on his own time and capacity, and the views expressed herein do not represent the views and opinions of the Canada Mortgage and Housing Corporation.
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