In the last few posts I quoted the former Deputy Mayor of Toronto, who pointed out that there are three things you need to get housing built: “You need the approvals, you need the people to build these things and you need a way to finance it…Right now, we’re having issues in all three.” We’ve seen that bureaucracy, as frustratingly slow as it is, is not the cause of the housing crisis; and that as challenging as the labour shortage and materials costs are, they’re at best one piece of the puzzle. So what about finance?
Housing supply is directly tied to finance: we live in a capitalist society, and developers and investors expect a return on their investment. You’ve probably heard it said that real estate is a good investment (“they’re not making any more land”), and that’s largely true. While the housing market fluctuates a lot, over the long term most land is appreciating in value. (We could talk about why you should consider the effects of climate change before purchasing waterfront properties, but that’s a discussion for another day!)
Financing Your Housing
There are several different types of housing supply, and they each have different factors that affect financing. For someone purchasing a home, there are three major factors: their credit score, whether or not they have a down payment, and the interest rate. Banks give out 30+ year loans in order to make housing affordable on a monthly basis. These factors stay the same whether you’re buying a bungalow or a townhouse or a condo apartment. For renters, the factors are different: cash flow is the most important, followed by credit score and references. Renters pay much more than owners, because their rent is calculated to pay the landlord’s mortgage and still earn the landlord a profit. The lack of a down payment therefore not only prevents them from buying a home, but it costs them much more for housing as a result (but that’s also a topic for another day).
But how do you finance the creation of housing units?
Developers often begin as builders who reinvest their profits into purchasing land for more building projects. Not all developers are builders; some developers are more focused on the investment side, and hire builders. Either way, they raise money through profits from previous developments, and sometimes through other investors. They access housing grants, when they can, and build whatever they think will maximize their return on investment in a given market.
In a previous post I talked a bit about builder’s formulas: they calculate the cost of the housing they build on a per-square-foot basis. The largest cost on any build is the land, and it’s generally much more difficult to get financing for vacant land than for an already developed property. So generally the developer invests their money in land, and gets loans for the costs of materials and labour. That means that interest rates matter a lot.
Interest rates are one of the key levers the Bank of Canada can use to control inflation. The general gist is that when average people have enough money that we can afford to pay more for everyday items, the cost of those items will rise until it meets what we can afford. If we can’t afford certain items, but we can get low-interest loans, then the cost of things can keep rising, because the cost of things in a free market is set by the principle of “what the market will bear” – i.e., how much we’re willing to pay for something. So by raising interest rates, the Bank of Canada limits our ability to access cheap debt, which limits our ability to pay more for everyday items, which limits the ability of retailers to sell those items, and over time the prices will come back down.
Housing costs have risen FAR faster than the rate of inflation, more than doubling in the past five years. Even so, when the Bank of Canada raised interest rates it wasn’t explicitly related to housing prices; it was to fight inflation in general. Even so, the housing market felt the impact of higher interest rates instantly. Here’s a chart of the market in February 2022, when rates first went up:
Much of the activity in the market at that point (most of it, at least in my experience) was for investors looking to convert owner-occupied housing into rental units. It was only profitable at those high prices so long as the interest rates were low. Since then, as the chart shows, there have been more ups and downs, and interest rates have jumped up several times along the way.
So in some sense, the supply of rental units was negatively affected by rising interest rates; but the overall supply of housing hadn’t changed, just the number of houses being converted to rental units by investors. Overall, all housing has seen a drop in market value; but the difference is offset by the higher interest rates. For the most part, it’s no more affordable to buy a home today than it was at the peak of the market, but more of the mortgage payment goes to the bank instead of to the seller.
Interest rates have affected developers a lot, too: if they finance the labour and materials they use to build houses, higher interest rates means they need a fast turnaround on the homes they build and sell in order to minimize their own cost of borrowing. But the higher interest rates also affect home buyers, so developers can’t expect to sell homes as quickly. Depending on how much they depend on bank financing instead of private investment, they might just hold onto their land until rates are more favourable. That’s one of the reasons there are so many housing projects that have already been approved but haven’t been started. So ironically, a Bank of Canada move to make housing (and other things) more affordable has also slowed down the development of new housing.
Ultimately, what the rise in interest rates is supposed to do is take the heat out of the market. Market forces tend to keep going in a particular direction unless something stops them: we all got used to rising housing values, and we started planning our finances around them, making decisions that (collectively) further increased the housing market. In theory, once things calm down enough the rates will be brought back down and we can be more careful this time. Right?
The problem is that we treat housing as a commodity to be traded, an investment strategy. In a capitalist economy anything can be converted into money, and the more demand there is for something the more money there is to be made. And there’s no demand greater than for things like food and shelter, our most basic needs. Food is relatively easy to make, and therefore plentiful; shelter is not.
There ARE regulations and programs that can make housing less appealing as an investment strategy, but for now our system is set up in a way that almost guarantees that housing will be expensive. This is another failure of neoliberal economics, which holds that if we make it as easy as possible for the market to function then we will all reap the benefits as investors use their wealth to produce goods and services, creating jobs along the way so that wealth will “trickle down.” The reality is that allowing necessities to be commodified has created market dynamics that ultimately cost all of us more just to meet our basic needs.