Overpriced Canadian Housing

There’s no doubt that the Canadian housing market is chronically over-valued. It has become an even bigger problem over the last few years as the prices of houses have pushed out new home buyers from owning and forced people to leave the cities to find cheaper housing elsewhere.

There is a widespread belief that one of the biggest contributors to this is foreign money being pumped in by (mostly) wealthy Chinese people looking to get their wealth out of China.  I believe that this argument is a distraction from the true systemic cause of the Canadian housing bubble. It’s nice to point the finger at someone else to say ‘they’ are causing the problem. Politically it is less risky to table legislation that targets foreign buying rather than looking inward and pointing the finger at ourselves.

Why do I think the foreign buyer cause is terribly oversold by the media? America has been the dream for immigrants for a long time, they get the bulk of the people trying to move into the country. However given the comparable amounts of land between the countries and similar economics, plus Canada’s high standards for accepting new citizens there is a big difference in house prices between our countries.  Certainly if it was simply supply and demand driven the wealthy Chinese people moving to the US would push their prices higher than ours. Instead Vancouver is more expensive than San Francisco housing. Vancouver is a good case study because it is not the most restrictive place for land (Venice, Hong Kong would be tighter) nor is it the head quarters of major global brands (compared to San Francisco or New York or London)

There is a hard truth in Canadian housing. We have a system here that compounds housing value and incentivizes home ownership with a regressive and uncapped tax benefit.  The fix is simple but perhaps political suicide.

The seed was planted that inevitably led to this situation a long time ago.  The principal residence capital gains exemption was added to the tax code to encourage home ownership. The intention was noble, allow people to take the appreciated value of their home and transfer it to a new one when they have a bigger family and need a bigger house.  The US went with a different approach – Interest on mortgage was tax deductible. The difference is subtle but important.

In Canada this created a tax loophole. People willing to move every few years were given a windfall of tax free money and lets face it. Most of us would take all of that and plow it into a bigger/better house, to get yet another tax free windfall a few years later. Rinse and Repeat.  What other investment can you get 20:1 leverage and tax free capital gains? It’s better than an RRSP and better than a TSFA in terms of tax benefit. Real estate was made to be an ‘investment’ rather than a necessity to live. These tax free gains have compounded year after year within this marketplace for so long now that trying to buy a house with after-tax dollars is an impossibility in some cities.

The primary residence capital gains exemption has turned housing into something that competes for our savings dollars.  Instead of investing in stocks or bonds, instead of starting our own businesses we buy big houses.

There is something I notice when travelling to the USA. People have money to spend on consumer goods – more so than in Canada. A smaller portion of their total budget is allocated to housing which leaves more to spend on things that churn the economy – trips, video games, the latest tech, books, restaurants.  High housing costs make everything else expensive in Canada because the salaries people earn have to be high enough to live. So these costs get passed back through to food, flights, and internet fees.

The final nail in the coffin for the capital gains exemption is that it is hugely regressive.  If you can afford a $10M home and it goes up to $12M in 2 years then you’ve made effectively $2M tax free. The wealthier you are the more you stand to benefit.  Anecdotally, the wealthiest people I’ve met have also been the ones that move the most frequently.

The rub is that people love their tax deductions.  We’re blaming the foreign buyers now and when that fails to solve the housing crisis we’ll blame lack of supply, When the builders can’t build fast enough to drop prices they’ll blame the building codes and regulations.

The fix is simple, take away the tax advantage, remove money from the housing market and put it back into the broader economy. The money currently tied up in housing can be put to work moving through businesses or investing in a broader array of assets.