Make New Homes Affordable Again
Ten pathways governments can use to restore middle-class housing affordability
Highlights
In most of Canada, new middle-class homes are substantially less affordable than they were two decades ago, even after accounting for changes to wages and mortgage rates.
New housing can become more affordable through some combination of higher wages, lower mortgage rates, and lower prices for new homes, noting that these three factors are not necessarily independent of each other.
We identify eight factors that influence the cost (and, therefore, the price) of new homes. Lowering any of these costs also enhances housing affordability.
These eight costs, along with higher wages and lower mortgage rates, provide ten separate pathways to creating middle-class housing affordability.
A “pathway” is not a policy, but identifying these pathways can help governments design better policies.
Looking back at the good ol’ days
Over at the Hub, Mike wrote a piece about the Ford government’s promise to allow a family to buy a brand new 1600-sq. ft. home in southern Ontario for under $500,000. We are nowhere near that reality, but it does raise the obvious question of “How would a government make this vision a reality?”
Or, to put it differently: What policy levers do governments have to make housing more affordable?
It really was not that long ago that buying the type of home Ford talks about at that price point was possible. One of our favourite Missing Middle episodes, titled Why You Can’t Build Cheap Homes Anymore tackled this question.
The episode discusses how Mike and his partner bought this 1250 sq. ft. house1, brand new, for well under $200,000 back in 2004:
Buying this new home today would cost over three times more than it did back then. If we use the WHAM Affordability Metric, which takes into account changes in middle-class wages and 5-year mortgage interest rates, it would cost a family 2.3 times more hours of work to buy and finance this home in 2025 than in 2004. Interestingly, almost none of that has (directly) to do with mortgage rates, which are almost the same today as they were in 2004.
If we look at the inputs to the WHAM metric, there are three pathways for homes to become more affordable for middle-class families:
Middle-class wages go up
Mortgage rates go down
Home prices go down or, at the very least, rise slower than wages
Instead, in London, home prices more than tripled, far exceeding the 75% increase in wages (neither figure adjusted for inflation). Mortgage rates moved dramatically over 20 years after returning to pretty much what they were, leading to a 2.3-times increase in wage-and-rate-adjusted home prices.
In Mike’s hometown of London, skyrocketing home prices are directly responsible for making new homes less affordable for a family today than they were 20 years ago. The word “direct” here is vital. It is worth noting that wages, mortgage rates, and home prices are not entirely independent of each other, and changes in one can impact the others, so wages and interest rates could have played an important indirect role.
Of course, this raises the obvious question: “Why does a new home cost in London so much today than it did 20 years ago?” On the episode, Mike and Cara discussed all of the inputs that go into building a new home,
However, we can be more granular than “home prices go down.” In the episode, Cara and I examined the inputs involved in building a home and how the prices rose over time, causing the cost of new homes to be substantially higher than it was two decades ago.
But my numbers were very rough figures, and London, Ontario, isn’t necessarily the most representative of Canadian geographies. Other analysts have engaged in similar exercises, often with more solid numbers than Mike’s back-of-the-napkin estimates. In a piece in Real Estate Magazine, Brad Jones, Chief Development Officer at Wesgroup Properties, breaks down the costs involved in building a $1.5 million condo unit in Vancouver as follows:
$294,000 (20 per cent) is for land acquisition
$490,000 (32 per cent) is for hard costs (i.e. labour, building materials)
$102,000 (7 per cent) is for soft costs (i.e. architectural designs, legal fees)
$92,000 (6 per cent) is for marketing and realtor commissions
$77,000 (5 per cent) is for finance charges and loan interest
$267,000 (18 per cent) is for government taxes and fees
$178,000 (12 per cent) is the gross profit margin required by banks to provide financing
New housing is made more affordable by finding ways to reduce these costs or, at the very least, finding ways to slow their growth.
If we include the seven items on Brad’s list, along with middle-class wages and mortgage rates from my list, we have nine different pathways that governments have to make housing more affordable. Brad’s list includes only direct costs, so delays from approval costs are excluded. These approval costs are not paid directly but rather inflate the costs on Brad’s list. I’ll add it as a tenth pathway.
This creates 10 different pathways that governments can use to make new homes, whether they be Brad’s condo example in Vancouver or Mike’s new suburban home in London, Ontario, more affordable.
Ten Pathways to Making New Housing Affordable Again
Raising middle-class wages.
Keeping mortgage rates lower than they otherwise would be.
Lowering the cost of and allowing for the more efficient use of land.
Lowering the hard (construction) costs of homebuilding.
Lowering the soft costs of homebuilding, such as legal fees.
Lowering transaction costs between buyers and sellers.
Lowering financing costs during construction and pre-construction.
Lowering government taxes and fees.
Allowing projects to get funded at lower profit margins.
Reducing approval costs and timelines.
Before we get into examining these areas one by one, there are a few things to note about policy pathways:
A pathway is not a policy. Governments don’t have a “make everybody’s real wages go up” button, or else they’d be mashing that thing 24 hours a day2. Rather, “raising middle-class wages” is the desired outcome, and there can be any number of policies governments could use to make this a reality.
A pathway itself can contain multiple sub-pathways. For example, slowing land price growth in Toronto can be done in many ways, including slowing population growth, which could be done in many ways, including making it easier for people to live somewhere else and commute to Toronto, which can be done in many ways, and so on.
A pathway does not necessarily imply that governments need to do “more.” It could involve new rules, regulations, and programs, as well as reducing or eliminating regulatory barriers. Thus, the pathway approach is neither inherently a big government nor a small government approach.
The pathways are not listed in order of importance.
Let’s examine each of these pathways one at a time. The discussion of each pathway is not meant to be exhaustive, as there are dozens of potential policies that could be beneficial (or harmful). If we left out your favourite policy idea, please do not infer that we believe it to be unimportant.
Details on the ten pathways
Raising middle-class wages. There are entire subfields of economics devoted to this, so let’s put it aside for now.
Keeping mortgage rates lower than they otherwise would be. The choice of wording here is important; this is about mortgage rates, not economy-wide interest rates.3 This pathway is not about having the federal government try to pressure the Bank of Canada to lower the overnight rate or in any way impact monetary policy, though governments do need to consider the impact their spending and tax policies have indirectly on interest rates across the economy. The pathway is specifically about mortgage rates, which governments can influence in a number of ways, including ensuring a competitive mortgage market. The federal government making it easier for homeowners to switch lenders at renewal is one such initiative. Reducing mortgage fraud can also help lower costs for honest buyers.
There is a belief that reducing mortgage rates cannot help increase affordability. The belief is that higher home prices will offset any rate reductions, as families will now be able to make larger offers, so buyers are no better off. This is similar to the belief that raising or lowering development charges has no impact on new home prices. Development charges impact the demand for land, so higher development charges are fully offset by lower land prices, so there is no change to affordability. While in both cases, offsetting does occur, it is typically not one-to-one, and the level of offset depends on a variety of factors. For example, 5-year mortgage rates plummeted from 10.69% in July 1994 to 6.98% in July 1997. Despite this, home prices fell slightly in London, Ontario, from $138,000 to $133,000 for a single-family home. Similarly, southern Ontario has experienced both skyrocketing development charges and skyrocketing land prices over the last two decades. Offsets to lower mortgage rates or development charges are not necessarily one-to-one and, under certain conditions, may not exist at all!
Lowering the cost of and allowing for the more efficient use of land. The importance of this cannot be overstated, given that it is 20% of the costs in Brad’s example, and for other projects, it can be well over half. It is also one of the pathways where governments have the most levers. They can decrease the demand for land by legalizing gentle density and creating more flexibility in how land is used. They can increase the supply of residential land by allowing land to shift from commercial and industrial uses to residential or by expanding urban growth boundaries, keeping in mind the cost of sprawl and the need to ensure homes in areas prone to flooding or other environmentally sensitive areas. Competition policy can play a role in ensuring land markets are competitive and fairly priced. Many activities will have an indirect impact on land prices; for example, if speculators are buying up homes and leaving them vacant, that demand will put upward pressure on both land and home prices. Finally, population growth will play an outsized role in the demand for land. This should not be taken to suggest that governments abolish immigration or not allow international students; rather, policymakers need to align their land-use and population growth policies, be mindful and realistic about the absorptive capacity of a variety of systems, and avoid decision-making in silos.
Lowering the hard (construction) costs of homebuilding. Policies under this pathway can include anything from building code reform to innovation policies to lowering import tariffs on construction materials. Given they’re the single-biggest component in Brad’s cost chart, policymakers in the housing space should pay careful attention to these costs, even if the policy solutions are not always obvious or straight-forward.
Lowering the soft costs of homebuilding, such as legal fees. This is one we have not spent much time thinking about, nor is it obvious (to us) what governments could do to lower (or reduce the growth of) these costs. In our view, it warrants further study.
Lowering transaction costs between buyers and sellers. Land transfer taxes count as one of those transaction costs, though they could just as easily be counted under “taxes and fees.” It is unclear what governments could do to lower transaction costs such as marketing costs and realtor fees without creating substantial unintended consequences, but just like with the previous pathway, it warrants further study.
Lowering financing costs during construction and pre-construction is ultimately a function of three factors: the interest rate applied to these projects, the amount of dollars being financed, and the length of time the projects are financed. Programs such as the CMHC’s Apartment Construction Loan Program (ACLP) provide vital low-rate funding to projects and could be expanded. The amount of dollars being financed is a function of overall cost, but it is also a function of when expenses occur. For example, development charges are typically paid upfront and thus need to be financed. If, instead, they were payable at the end of the project (as Jones recommends in his piece), it would reduce the length of time they need to be financed, and on an ownership project, the developer may not have to finance them at all, if they get paid by the buyer before the time the charges are due. This would substantially lower financing costs. Finally, finding ways to accelerate approval processes (pathway #10) would also reduce the interest costs on projects.
Lowering government taxes and fees. This is a lever that governments directly control, and it is a large one, as construction-related taxes can account for over 30% of the cost of some projects. Reforming development charges and the other alphabet soup of municipal housing construction taxes is massively overdue. It is important to note that development charges and other municipal fees are incorporated into the final price, which is subject to land-transfer taxes and the GST/PST (where applicable), creating a tax-on-tax.
Speaking of the GST and PST, they only apply to new homes (not preexisting ones), so they act as an additional development charge when building new housing. Like municipal development charges, they slow new housing construction. Lowering or eliminating these taxes lowers new home prices, helping boost supply.
Allowing projects to get funded at lower profit margins. As Brad notes in his piece, banks require a certain gross profit margin before they will finance a project. We are unsure if there are any policies the government could enact that could lower this rate without unduly adding risk to the system, but as we have said a few times in this piece already, it is worth studying. Note that lowering construction costs does allow homes to be built at a lower dollar profit, while leaving margins untouched.
Reducing approval costs and timelines. These are not typically direct costs, but they increase risk and raise other homebuilding costs. Given that approval speeds vary considerably across municipalities and provinces, governments have substantial control over this pathway and can implement reforms such as Edmonton’s automated development approvals system.
In summary
In communities from Vancouver to London, Ontario, newly built homes became less attainable to the middle class over the last 20 years, as home prices rose faster than wages while interest rates rose and fell and rose and fell again, to return right back to where they started. While governments cannot and should not try to control wages or home prices directly, they can create housing affordability through well-designed policies aimed at one or more of the ten pathways to housing affordability.
The house in the picture isn’t the exact house, but ours was the same model and the same colour, so much so I would not be able to tell them apart from a picture.
They’d mash it like they were playing Konami’s Track and Field. If you know, you know.
A very rough first draft of this piece did use the term “interest rates”, which was a mistake.