Supply Constraints increased prices of apartment condos in Canadian Cities

PDF - Report

This report looks at if supply constraints increases prices of apartment condominiums in major Canadian cities.

Housing affordability concerns have risen in some major Canadian cities since the end of the U.S financial crisis. However, unaffordable housing itself is not a market failure. When the price of housing is similar to the cost of production, or the marginal cost, the market is working properly. If the house price and marginal cost are similar, housing prices won’t decrease by adding more supply. If prices are above the cost to provide additional units, the market has failed.

Market failure has several possible causes:

supply constraints
regulatory and non-regulatory
lack of competition

To set apart these major causes, the analysis must establish whether suppliers can respond to higher prices by building more units. If they cannot, then it is apparent they are constrained in some way.

Author:: CMHC
Document Type:: PDF
Date Published:: December 17, 2018

Download

research-insight-supply-constraints-increased-prices-ca-cities-69631-enpdf

Key highlights in Vancouver, Toronto and Montreal

Prices are compared to marginal costs on a per-square-foot basis. Two price measures were considered:

the benchmark price of all units in the area covered by the Real Estate Board
the average price of units built within five years of their closing date

Both price measures rose over the last decade in the 3 cities evaluated: Toronto, Montréal and Vancouver.

The marginal cost of producing new apartments unit is far below the average price per square meter that they sell for in Vancouver and Toronto. This is not the case for Montreal as a whole. Individual municipalities within a larger metropolitan area may have different approaches to development and different geography, which may affect how constrained construction is.

Vancouver highlights show much higher pricing for units compared to the cost to produce them:

The prices of apartment condominium units are much higher than the cost to produce them.
Unlike in the other 2 cities, at no point was the ratio of price to marginal cost ever below one.
Strong demand likely opened the gap between prices and costs.
Condominium markets in Vancouver are not providing efficient outcomes.
In 2018, the majority of units are in municipalities other than the city of Vancouver, specifically in Burnaby and Richmond. Municipalities near the centre of Vancouver have price-to-marginal cost ratios close to that for the overall Vancouver area.

Toronto shows prices measured greatly affected the results:

In Toronto the price measure used greatly affects the results.
Both measures showed that the market is unlikely to be constrained at the beginning of the time period evaluated.
When the benchmark price is the price measure considered, the ratio of price to marginal cost remains near one throughout the sample.
When only new units, the structures that builders are building, form the price measure the results change. The ratio of prices to marginal costs greatly exceed 1.3 and suggests that new construction is constrained in Toronto. Using only the benchmark price masks the conditions that suppliers of new homes face.
The vast majority of condominium units built within the last five years in the Toronto census metropolitan area (CMA) were in the city of Toronto. Thus, there was no analysis of the census subdivisions performed for Toronto.

Montreal highlights that prices weren’t above costs:

Prices were not above costs in the Montreal area.
Like in Toronto, the ratio between price and marginal cost increases when the prices of new units are the basis of comparison. However, the ratio remains below the identified threshold.
The city of Montreal itself has a ratio of price to marginal cost above 1.3, while other municipalities off the main island, like Laval, do not. Increased sprawl and higher prices in the central city suggest that Montreal’s height limit may be constraining.

To determine if we have observed constraints on supply, we must determine if builders can react to changes in demand indicated by increasing prices. If a supply constraint prevents builders from responding to higher prices with more units, we would expect little relationship between past prices and current apartment starts.

There is no statistically significant relationship between apartment starts and past prices in the Toronto or Vancouver areas.
Such a relationship exists in Montreal, the area analyzed that shows no evidence of constrained supply

This suggests that supply constraints have muted supply responses in Vancouver and Toronto. Price frictions in Toronto and Vancouver are low compared to those observed in cities in the U.S., Australia and New Zealand.

This report is part of the Research Insight series. Read the full report Supply constraints have increased prices of apartment condominiums in Canadian cities.