In recent years, there has been a growing consensus among consumers, businesses, and government that Canada is simply not investing enough in housing development. The issue has grown even more heated over the past two years given record levels of immigration to Canada, a development that's spurring even more voracious potential housing demand growth compared to just a few years ago.

The reality, however, is that Canada has seen a substantial increase in housing investment over the past five years, resulting in record levels of new housing construction. Despite higher interest rates and construction costs, the number of housing units under construction in Canada was still at a record high of over 350,000 at the end of 2023.

The growth has been mainly driven by the construction of apartment units — including rentals but especially condos — in major urban areas of the country, with over 280,000 apartment units under development going into 2024.

While much of the demand for condo units is from owner-occupiers, a growing number have also appealed to speculative investors who do not reside in these properties but are attracted to them solely for potential capital appreciation.

Given record levels of new home construction over the last several years, residential investment has emerged as a major driver of the Canadian economy. For example, over the last five years, the share of residential investment as a percentage of GDP in Canada increased to a record level of nearly 10%. This is not only the highest level of residential investment ever seen in Canada, but is also a much higher than the level of contribution in other developed countries such as the U.S.

Further investment in housing may be an admirable political goal. However, it risks diverting even more of the economy’s limited resources — both capital and labour — into what economists sometimes view as a relatively low-productivity sector.

While housing investment does provide a key need for shelter, it does not drive real income and productivity growth to the same extent as investments in capital equipment and technology. Indeed, the U.S. has seen far larger investments in these two sectors compared to Canada and consequently, it has experienced much faster productivity and real income growth than Canada, especially over the past five years.

During that period, Canada also saw its relative living standard — as measured by GDP per capita — slip against the U.S. and a number of other developed countries.

One major segment in which housing investment in Canada appears to be consistently lagging is the construction of single detached dwellings. At the end of 2023 only around 30,000 single detached units were built compared to over 40,000 units during the late 1980s when the country’s population was nearly half the size it is today.

Shortages of developable land, largely due to restrictive zoning, is the primary reason for under development in single detached homes and other forms of ground-oriented housing. As a result, single detached homes have increasingly become a legislated scarce good in many urban markets, particularly Vancouver and Toronto.

Given the supply shortage and continued demand, single detached home prices have more than doubled since the late 1980s and now average well over $1,000,000 in Vancouver and Toronto.

Its important to note, however, that the rapid price appreciation and affordability challenges of owning a single detached home in major urban areas of Canada is a rational outcome of scarcity economics. Unless the supply of these types of homes is markedly increased via the release of currently restricted land, fundamental imbalances are likely to continue driving prices for single detached and other ground-oriented homes much higher over the long term, all else being equal.

In contrast, Canada has recently experienced a significant boom in the construction of purpose-built multifamily rental units. But even though potential supply has been significantly ramped up, a protracted shortage of this product remains due to nearly three decades of underinvestment.

To illustrate, approximately 200 multifamily rental starts per million people tends to preserve an equilibrium between demand and supply in the apartment rental market. Over the past three decades, Canada routinely underproduced this level and only began to make up for lost ground in the last three years. As a result of the existing supply and demand imbalance, Canada’s apartment rental vacancy rate fell from about 5% in the early 1990s and hovered at an extremely tight 2% to 3% thereafter.

Mainly due to rent controls in several provinces, it is important to note that despite the tight rental market conditions, average apartment rental growth did not grow much faster than inflation. This is especially true compared to the market-driven price appreciation experienced by the shortage of single detached homes over this period of time.

“Under market” apartment rents have created a vicious circle that is now resulting in attracting even greater demand to the more affordable rental market while further exacerbating the supply problem. This is because builders typically need much higher rents to make their development economics work.

To be sure, the acceleration of rental unit starts per capita by 2018 was driven by both low financing costs and higher rents in non rent controlled buildings. Development of these units peaked at a rate of over 500 units per million people in 2022. However, the rapid increase sharply unwound last year.

This was not necessarily because of a drop-off in the absolute level of construction — which is still near record highs — but due to a massive increase in population from surging immigration, especially non-permanent residents who tend to rent.

The net result has been a significant drop in Canada’s apartment rental vacancy rate which fell to just above 1% at the end of 2023. Meanwhile, average rents in non-rent controlled buildings have continued to surge. Even with the eventual delivery of new supply currently in the pipeline, projected apartment vacancies rates are expected to remain below 3% given the robustness of rental demand.

In contrast, the United States, which has historically seen far less constraint around rental apartment development, has averaged about 200 multifamily rental units per million people over the past three decades. As a result, its apartment vacancy rate has consistently remained higher than Canada’s at about 6% on average.

However, an oversupply of rental units began to emerge in the US over the past year. As a result, the apartment rental vacancy rate in the U.S. recently increased to almost 8% — nearly an all-time high — while average rent growth is also cooling sharply.

The takeaway from this analysis is that solely leaning on the supply side to address the housing shortage issue in Canada may not be a silver bullet given that new construction is already going at full throttle. Pushing even more resources toward new housing development would make an already highly dependent economy even more reliant on residential investment to the detriment of other sectors and to some extent productivity growth.

Consequently, policies designed to limit potential housing demand in conjunction with supporting new supply could improve the balance in housing market conditions. Immediately decelerating rather than increasing population growth through immigration is one major way to accomplish this.

In addition, targeting immigrants in skilled trades who can support new housing supply — rather than targeting economic immigrants with assets that immediately put pressure on housing ownership demand — could also be helpful at the margin.

Another policy direction is to create disincentives to prevent speculative investment, especially in the condo market. This speculation has not only diverted capital away from other productive segments of the economy, but may have also limited the amount of housing supply available to potential owner occupiers.

To be sure, there is no measure that will immediately bring balance to Canada's housing market in the near and medium term, given the forces that are already at work in the market. But easing potential long-term demand while supporting supply would be helpful for both the housing market and economy in the long term.