Understanding the Housing Crisis

Housing is too expensive everywhere in Canada. We are being told that what is making housing unaffordable is a lack of supply. That is, we are led to believe that there are a lot more people who need housing than there are houses available. That narrative doesn’t stand up to scrutiny. According to the Canadian Observatory on Homelessness, it is estimated that there are, on average, 235,000 homeless people in Canada in any given year. At the same time, we have plenty of empty houses to house them. According to Stats Canada, in 2021, for example, there were 16.4 million dwellings in Canada. In the same year, 7.5% of them were unoccupied. That means that there were 1.23 million empty dwellings in Canada. In other words, there were roughly over 5 times more empty houses than there were homeless people. Clearly, supply is not the problem. Logically, if we have an empty house, we can house people. Furthermore, the total population of Canada in 2021 was 35,151,728 (2021 Canadian Census), which means that there was enough empty housing for about 3.5% of the population. This means that housing should be significantly cheaper if you believe the cost of housing is determined only by supply and demand.

Market Value vs Book Value

If a lack of supply is not the reason why housing is unaffordable, then what is the reason? To answer that question, we need to look at the housing system as a whole and understand all the different factors that contribute to the cost of housing. It helps to look at it from an accounting perspective. We can use accounting to break down the different costs and the different ways in which the price of housing is measured. Accountants use two different methods to value an asset such as a house – book value and market value. When we talk about housing supply and demand, we are talking about market value. Market value is determined by how much people are willing to buy and sell a house, not how much it is worth. There is no single true number that determines the true value of a house. Market value is the value that is at the very center of the housing mainstream narrative. The narrative focuses on market value while ignoring book value. It does this because book value is significantly lower than market value. The cost of building a house is significantly lower than the market value, which makes building and buying housing a very profitable kind of investment. Furthermore, the market value of housing tends to increase over time, while the book value tends to decrease, as housing becomes older. This is why we can sometimes come across a dilapidated house that is worth over a million dollars in the market. This is also why we have so much empty housing while the cost of housing is still so high because housing is treated as an investment, so some people speculate and buy housing to hold and sell later for a higher price, artificially pushing demand up and inflating the cost of housing. We can think of book value as closely associated with an objective value of something, while market value is more subjective and can vary from person to person.

Assets = Liabilities + Equity

While the distinction between different kinds of values helps increase our understanding of the problem, we need to delve deeper into the accounting involved. We need to understand how it looks on a balance sheet. A balance sheet is a financial statement that shows a summary of the financial condition of an organization or individual. In our case, we want to look at the financial condition of an individual and, in particular, their housing situation. This can vary depending on whether you own a house or you rent. I will cover both, but we will look at ownership first because we need to understand ownership before we can understand renting. A balance sheet is divided into two sides. On one side we have the assets, the objects that are possessed by the individual. On the other, we have liabilities and equity. Liabilities are the value of everything that the individual owes to others while equity is the value of everything that the individual owns. In other words, the asset side tracks everything that is in the individual’s possession while the liabilities and equity side tracks who owns what the individual possesses.

Building and Land

Let’s start with the assets. First of all, when we talk about housing, we are talking about two distinct assets – the building and the land. The value of the building is better reflected in the book value, while the value of the land is better reflected in the market value. The value of the building tends to go down because the building gets old over time. The building is like a car, it loses value over time. That means the market value of the building alone also tends to go down. Someone wouldn’t want to pay for a run-down house the same amount they would pay for a brand-new mansion. But the value can also go up if the owner of the house invests in improvements. Improvements, such as expanding a house by adding another room, increase the value of the house. As the house gets older, we amortize its value. That means that, over time, we decrease the value of the house in our financial statements. This is not an exact science. There are many ways of amortizing the value of an asset. For personal purposes, any method can be used, but for tax purposes, there are rules to be followed, because different methods of amortization can have significant effects on financial statements. While the value of the building tends to go down, the value of the land tends to go up over time. That’s the main source of the market value of the real estate – the building and the land combined. Land doesn’t get old over time, so it’s not amortized. In addition to that, land tends to get more developed over time. As a neighborhood gets developed, the land gets access to more infrastructure and amenities. It is that access to infrastructure and amenities that increases the market value of the land. This is the reason why real estate is significantly more expensive in a big city with a lot of infrastructure and amenities compared to a small rural town with little to no infrastructure and amenities close by. The land is the source of most of the real estate value. The land is the first component that makes housing extremely expensive.

I must now go on a side tangent to discuss a serious economic implication of these facts. An implication that is rarely ever discussed. If real estate is always more expensive in cities, that means that investing in real estate is always more profitable in cities. Of course, the first thought that comes to mind for most of us is that this explains why real estate is so expensive in cities. But there is more to that. If one thinks further about the economic implications within the context of a system dominated by private investors who seek to always maximize their profits, then one is bound to conclude that most investors, if not all, will always invest in cities that are already expensive. This will not only put upward pressure on the cost of housing in cities, but it will also leave smaller cities and towns largely underdeveloped. There are thus two adverse economic consequences of this economic arrangement – the overdevelopment of cities, with prices reaching ever higher beyond the reach of most of the population, and the underdevelopment of towns. This is part of the reason why the private market of housing doesn’t work. Another reason why it doesn’t work is because housing is not something that one can choose not to spend money on. Everyone needs a house to live in, and they will do whatever they can to pay for it because they need it and there are no substitutes for it. In economics, we call that “price inelasticity”. That means that a change in price has very little to no effect on demand. This means that the price mechanism doesn’t work effectively, because an increase in prices doesn’t lower demand, allowing the private owners of housing to charge more and more for housing.

Mortgages

We have, so far, covered one side of our balance sheet. On the other side, we have liabilities and equity. That is when everything starts to get a bit more complicated. First of all, when you buy real estate, unless you are rich you are not going to be buying it with cash. You will have to go to the bank and get a mortgage. The mortgage is your liability to the bank. Let’s say, for instance, that you buy a house for $100,000. An absolute steal, these days. You paid a 20% downpayment of $20,000. That is your equity, the amount of your house that you own. The house is worth $100,000, so that means you need an $80,000 mortgage. That is your liability, the amount of your house that the bank owns. You don’t really own your house until you pay off the entire mortgage. But you are also dealing with a private bank, a bank that wants to make money off of you. So the bank charges you interest to access that mortgage. The interest is also not just a flat interest that doesn’t change over time, it is an interest that compounds. They don’t charge you interest only on the amount you borrow, they charge interest on the total amount, including on the interest you owe to them. That has an exponential, compounding, effect. This is why mortgages can get very expensive. Interest on the mortgage is the second component that makes housing extremely expensive.

Interest can also change over time. Mortgages don’t have a set interest you pay until they are paid off, the interest changes over time. For that reason, some people might get a mortgage when the interest is low and they can afford the mortgage payments, only to be surprised 5 years later when the interest goes up and, with the interest, the mortgage payments go up too. All of a sudden, they can’t afford their mortgage anymore and have to sell or lose the house. This is what is happening right now. A lot of people got into the housing market in 2020, when the Bank of Canada's interest rate was 0.25%, but interest rates have gone up to 4.75% and, now that they are up for renewal, mortgage payments will go significantly up for a low of people. We are on the verge of a mortgage renewal crisis. Regardless of how much interest you pay, the cost of the housing, when interest is taken into account, is always higher than without the interest. The amount of money you pay on interest can often be higher than the original loan amount, the amount you borrow to purchase the house. For instance, if you need $399,999 to purchase a house and the interest rate is 2.96% for 30 years, you pay a total of $204,181 in interest, bringing your total cost to $604,180. If the interest rate goes up to 7.7%, the amount of interest you pay is now $627,530, and the total cost of the loan is $1,027,529 – over twice the actual price of the house. This is why if your interest goes up you might end up having to pay the mortgage for much longer in order to be able to afford it, which also further increases the cost of the mortgage.

While all this is going on, you have to wonder exactly what kind of service the bank is offering. You might say to yourself, “ok, but at least the bank is taking a risk by loaning money from their deposits”. Not quite. Contrary to popular belief, private banks don’t loan money that they already have, they create money out of thin air, which they then loan to you while charging you interest. They do little to no work and produce no value, yet you have to work to give them money for nothing. All this money that we are forced to give to the banks to access things that we need, such as shelter, is money that we have to work for and which they receive for free from us. They may have the ability to issue money out of nowhere, but we are the ones who actually produce the money through our productive work. This state of affairs is thus grossly unfair. It not only makes housing very expensive; it transfers wealth from the people who produce to people who don’t. This is similar to the relationship between a landlord and a tenant. The tenant does the work and produces the value while the landlord reaps the benefits of the tenant’s hard work. Then, of course, the landlord might pay some of that money to the bank, and thus, the bank may still be the ultimate beneficiary, but if the house is completely paid off, the landlord is effectively in a similar position as the bank.

For-Profit Development

All of this assumes that the house is already built. Building the house is a crucial part of this process. This is where it becomes more difficult to decrease the cost of housing because a lot of the costs of building housing are legitimate. First of all, we need to purchase all the materials required to build the housing and transport them to the site where the house is going to be built. Then, we need to pay workers to build the house. In a city, we also need to take into account all kinds of infrastructure such as powerlines, water, sewage, and telecommunications. In addition to all that, the city might have certain requirements that must be met. These requirements may create some bureaucracy and unnecessarily increase the cost of housing, but they are generally practically insignificant compared to the cost of interest and land. Still, if we want to make housing more affordable, we should invest in better land planning systems so that housing can be approved by neighborhoods more quickly.

All of this, however, is not done in a vacuum. There is always some kind of organization that is tasked with building the house. Usually, that is a for-profit development company. The company will be owned by one or more individuals who will expect a profit from the activities of their company. All of the work will be done by workers, including managers, but the owners also expect a return. Therefore, this profit will become the third component that makes housing expensive. All of the work could be done by the workers themselves without any involvement from owners, but since owners have an entitlement to control and extract profits from the company, they sell the house for a value that is higher than the cost to produce the house, making it more expensive than is necessary.

Solutions

What can we learn from all this? The lack of affordable housing is not caused by a lack of housing but, rather, by systems that are specifically designed to extract wealth from people who work and give all that wealth to people who don’t. What we need to do, then, is to create alternative systems that eliminate that transfer of wealth. Those systems will have to be owned and controlled by the people. That way, the people can create wealth through their work and retain their wealth.

The first step is to create a community cooperative that spans an entire city. Every resident must be an equal member of the cooperative, owning one share of it and being able to cast one vote when a decision needs to be made. Next, the community cooperative needs to own a cooperative land bank, which can hold all the land of the city. In this manner, we can remove the cost of land from the cost of housing. Instead of buying and selling real estate, we can, then, buy and sell only the houses. Next, the housing can be financed by the land bank, which is owned and controlled by all the residents, without charging any interest rate. The bank can use the value of the land it holds as collateral to issue the currency required to build the housing. This would also prevent inflation because it ties the amount that the bank can issue to the value of the land that it has available, further preventing the cost of housing from going up. Finally, the housing can be built by a non-profit cooperative. Workers can be paid well while still allowing us to build the house for a lower cost because we don’t have to cover the profits of the owners.

All of these systems combined could decrease the cost of housing to a quarter or less than what we have now. Take my earlier example. The cost of the real estate, with the house and the land, was $399,999. Typically, the cost of the land is at least half of the cost of the real estate, often more. So, let’s say, the cost of the land was $200,000. A typical profit margin for construction companies is 7% of the cost of the real estate, so around $28,000 in our example. We can also remove the cost of interest. At 2.96% that was $204,181 and at 7.7% it was $627,530. Therefore, given our example, we could expect the cost of housing to fall from a maximum of $1,027,529 at the higher interest to a total of $172,000. That’s around $800,000 cheaper. This means that instead of paying $2,854.25 per month, you would be paying $477.78 per month. That is $2,376.47 cheaper, and FAR more affordable.

Addendum

There are also more ways to make housing more affordable. For example, detached houses end up being more expensive for communities because it is not an efficient use of land. Apartments and, generally, denser residential zoning decrease the cost of housing for everyone. But there are more factors to take into consideration. For instance, we all have living rooms that remain idle for much of the day because we are busy working. We could, for instance, build co-living spaces where we could share living rooms. This would further decrease the cost of that housing, while reducing the number of products we need to purchase, reducing our carbon footprint, and increasing socialization, which also reduces mental health issues such as depression.

The network distribution of buildings must also be taken into account. A neighborhood composed of only houses is less valuable than a neighborhood that has businesses and amenities within walking distance. Mixed development increases the value of land by making amenities more easily accessible. It also decreases our reliance on transportation, saving energy and reducing our carbon footprint. Relying on walking instead of driving also improves health outcomes for everyone. Plus, the value of land can be further increased by increasing access to public transport that can connect different neighborhoods. All of this increase in land value translates into a greater capacity to further develop infrastructure in the solution I proposed. It creates a feedback loop where the more we invest in infrastructure the greater economic capacity we have to further develop infrastructure. This is a far superior system to one that depends on property taxes and parking tickets to raise money for infrastructure development and maintenance.