Focus
June 27, 2025 | 14:25
Supply, Meet Demand
Economics
Economics
Fixed Income Strategy
Economics
Economics
Economics
Economics
Economics
Economics
Fixed Income Strategy
Economics
Economics
Economics
Economics
Supply, Meet DemandHousing affordability will return to pre-pandemic norms through a combination of market dynamics, income growth, a modest reduction in borrowing costs and firm construction activity. Policymakers can help. |
|
Canada’s housing market remains stable, but subdued, and construction activity continues to push valiantly ahead while the new Federal Government is set to implement various housing-related policies. Our long-held fundamental views on Canadian housing haven’t changed much. That is, domestic demographic fundamentals were producing strong and manageable market conditions, before deeply negative real interest rates and an explosion in population growth took prices and rents to the moon. This has been a very contrarian position as the popular narrative has focused solely on supply shortfalls. We continue to believe that the demand curve matters; national aspirations to double supply will not be met; yet affordability will return to pre-pandemic norms through a combination of market dynamics, income growth, a modest reduction in borrowing costs and firm construction activity. Don’t Ignore the Demand Curve!Let’s start by calling a spade a spade. A strong but fundamentally well-behaved pre-pandemic market exploded when the Bank of Canada cut interest rates to zero and promised Canadians that they would remain low. Deeply negative real borrowing costs drove prices higher (Chart 1), triggering expectations of further price gains and speculative activity. Market psychology is hard to ‘model’, but it is vividly clear if you’re watching—the market went quiet almost the minute the Bank of Canada began raising rates. As it stands now, housing valuations continue to adjust to neutral borrowing costs, and they should do so further in the year (or more) ahead. Meantime, Canada’s population was surging by nearly 1.3 million people per year (3.2%) at the height in 2024. The massive inflow of non-permanent residents was a policy oversight sitting in plain view. Now, the temporary resident caps announced in November 2024 (and carried on by the current government) will cut that group’s share of the population to 5% from above 7%, resulting in net outflows of more than 400k per year over the next two years, and a sharp slowdown in overall population growth. Interestingly enough, but not surprisingly, rents in some major cities began to roll over almost the minute those caps were put in place. |
The unfortunate side of the demographic story is that the explosion in immigration took place right as the peak of the Canadian millennial cohort was moving through their home buying years, creating intense competition for housing. Like the Boomers before them (around 1990), that cohort has been driving single-detached housing demand. Ironically, the push to build more units has led to a pipeline of smaller condos, which had been great for investors and renters, but did little to satiate single-family demand. The moment of maximum demographic stress is actually behind us, with the 24-39 cohort now expected to see growth slow sharply over the next decade (Chart 2). That is partly the result of a more tightly controlled immigration program, but also the fact that the bulk of the Millenial group has now pushed past their first-time home buying years. Pulling it all together, multiple demand-side factors, which all violently crossed paths at the same moment, are set to run much cooler in the years ahead and help balance the market. Supply takes yearsPrivate markets are very good at responding to supply-demand conditions, as best as they can. While real estate demand can shift in minutes, supply decisions can take years to build out. Indeed, there is a near-record 350k units under construction in Canada, which surpasses even the 1970s building boom in per-capita terms. We also estimate that household formation is in the process of stepping back down to around 210k per year (Chart 3). That follows changes to the federal Immigration Levels Plan, and the fact that Millennial household growth has likely peaked. At the same time, we account for the fact that household numbers were likely suppressed by strained affordability in recent years, with some estimates pointing to a potential unbundling of up to 600k households over time. With that in mind, a continued elevated and sturdy rate of construction activity, combined with the aforementioned demand-side factors, should gradually balance the market. Policy measures incomingHousing was a major pillar of the Liberal platform during the 2025 election. Some major considerations: Build Canada Homes and a major supply push: Consider us skeptical in the government’s ability to bring the right amount of supply to market in a cost-effective way. Aside from raw completion numbers, the other aspect of the supply-side narrative that gets overlooked is the type of supply. For example, doubling the output of smaller condo and purpose-built rental units will not only saturate those markets further, but do little to alleviate the stress on single-family ownership. |
|
Using Southern Ontario as an example, the byproduct of past decisions to intensify (e.g., the Places to Grow Act/Greenbelt) has been to increase the relative scarcity of single-detached housing, right at the moment we needed it most from a demographic perspective. The result has been movement of young families across/outside the province to areas with more appropriate housing. One could even argue that facilitating that movement with better infrastructure into/out of the GTA would itself be the best way to create single-detached affordability. Modular housing investment: Ottawa plans to provide $25 billion in financing, as well as new orders, to prefab/modular home builders. While this might not be a game changer, any measures to improve productivity in construction are worth pursuing. Tax incentives: The GST on new homes will be eliminated for first-time buyers (up to $1 mln and reduced up to $1.5 mln) with a contract as of May 27, 2025. Ottawa will also bring back a multi-unit tax incentive allowing the deduction of net rental losses (including depreciation) against other sources of income. While market conditions are the overriding factor—valuations and rent dynamics remain challenging—more favourable tax treatment will spur more investment than otherwise would be the case. Development charges: The federal government plans to subsidize municipalities through housing-related infrastructure investment, in exchange for 50% reductions in development charges. It appears that it will be limited to multi-unit housing for a five-year period. There is scope for wider support here given where supply is needed, and that those costs are either passed on to the end buyer, or prohibit projects from getting underway. Over the past decade, development charges in Toronto have surged by more than 200%, far outpacing both home price growth and inflation (Chart 4). |
Approval times: Arguably the best way government can help the market function is by setting a favourable environment and then getting out of the way. Given the nature of real estate—fast-changing demand, but long supply lead times—there should be a full-scale push for policy that speeds up the responsiveness (incresaes elasticity) of supply. Ottawa will aim to simplify building codes, streamline inspections, and standardize some designs, among other measures. The Canadian Homebuilders Association notes that approval times average 12 months across select Canadian cities in 2024, and 20-30 months in some GTA municipalities. Coincidentally or not, markets with strong population growth but very little ‘lack-of-supply’ narrative (e.g., Edmonton, Regina, Calgary) have some of the fastest approval times in Canada. |
|
Key Takeaways
|