The Need for Certainty

THE NEED FOR CERTAINTY IN HOUSING: SHORT-TERM POLICY INITIATIVES CAN BE COUNTERPRODUCTIVE

February 26, 2025        Ian Ellingham, MBA, PhD, PLE, FRAIC

Over the past few years, housing shortages have provoked Canadian governments into a set of initiatives that may appear to alleviate the issue, but may actually work to increase it. 

In the face of an ongoing housing shortage, it is necessary to recognise that real estate is both simple overall but often complex in the details.  Among the simpler characteristics of housing is that it is inherently capital-intensive to create, and sources of capital are limited to three forms:

Owner-occupiers assume the capital obligations associated with housing through their own financial contributions and taking responsibility for mortgage debt.

Investors, large and small, do the same, with the expectation of ongoing or future rental income or capital gains. 

The state can borrow at favourable rates, but most governments dislike the substantial and expensive long-term commitments housing-creation programmes involve. 

Through the twentieth century various policies successfully encouraged owner-occupation, but not everyone wants ownership or can afford it.  Currently, the creation of increasing levels of uncertainty will deter investment by the private sector, meaning governments may have to look again, reluctantly, to serious social housing initiatives.

Another simple characteristic is that housing is subject to the forces of supply and demand, and because the supply of housing incorporates the existing stock and little can be added annually; rising demand will be primarily manifested as increased prices.  Increased demand results not only from a rising population, but also from decreasing household size and widespread expectations of increasing amounts of personal dwelling space.  Current new construction in Canada hovers around only 1.5 percent of the total housing stock per year. 

Time always is important when considering real estate due to the long time frames required for development and the realisation of returns.  Now, with the generation of boomer developers, home-owners and investors departing the scene, there is a need for them to be replaced by emerging generations, and they need to see promising opportunities.  Business almost always abhors uncertainty, and demands increased returns when uncertainties increase.  Real estate is especially exposed to uncertainty due to the long time frames required for development and the realisation of returns.  Moreover, real estate is an easy target for taxes and government policy, as it cannot be readily moved elsewhere, as can many other businesses.  For the private sector, other opportunities exist elsewhere that involve less risk, time and effort.  For example, the American S+P 500 index has a long term annual return of 10.26% per year (approximately 6.4% when adjusted for inflation) without demanding the immense amount of effort and risk exposure associated with real estate.  To the private investment sector, and to an extent the owner-occupier, real estate returns have to exceed the risk adjusted returns on alternative opportunities before investment will occur. 

The usual time taken to create a new housing project is longer than the time between elections, creating a mismatch of time frames.  This means that governments at all levels will attempt to resolve housing issues with short-term patches that may actually have the effect of deterring longer-term development, because of the uncertainty they create among industry participants who may worry about what else might be coming over the long lives of their projects.  The recently-implemented vacant housing taxes, higher transaction fees, development charges, increased capital gains taxes and even the threat of vacant site taxes likely all work to deter new housing development. 

Real estate development is also a complex industry, with numerous participants, sometimes intricate financing arrangements, and intricate supply chains and labour requirements, so disruptions with cost implications can occur in many places.  The field of real options analysis, when applied mathematically to real estate, suggests that when uncertainty increases, the value of associated options rises –in particular that of the option to develop.  That means that it may become better to wait than proceed with development.

If the creation of more housing is the objective, private sector involvement should be encouraged, so, throughout the system, levels of uncertainty need to be reduced, and this includes dealing with matters of taxation, regulation, and times to obtain various regulatory permissions.  Alternatives include the acceptance of ongoing housing shortages, or the creation of large and expensive social housing programmes.

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