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The Canadian housing market is experiencing the opposite of what is assumed in urban economic theory. This theoretical paradox has causes and consequences. We take a dive into what this means and conclude by providing a potential solution to the paradox.

What does urban economy theory assume? 

Urban economic theory assumes housing prices and rents are intrinsically linked. The value of a dwelling is assumed to be the present value of future cash flows (such as rents) generated through propriety. Thus, when rents increase, so should housing prices. 

What is the paradox? 

Housing prices and sales in Canada are decreasing, while rents are rapidly increasing. The Canadian housing market is experiencing the opposite of what is assumed in urban economic theory. 

Take Toronto, Canada’s largest city, as an example. Since 2021, rents for 1-bedroom apartments increased 20%, 2-bedrooms increased by 15.3%, and 3-bedroom units went up by 12.8%. Overall, there has been a 30% decrease in stock availability in the city within a year. This is also taking place beyond major Canadian cities. In Halifax, Nova Scotia, vacancy rents reached less than 1% in 2022. In London, Ontario, rental rates have increased 28.5% in just one year. 

What is causing the paradox? 

A few key contributing factors can be identified as causing the paradox: 

Hikes in Interest Rates: rising rates have increased mortgage rates, causing hesitation and postponement of ownership by aspiring homeowners, resulting in longer than expected stays as renters. 

Resumption of Economic Activities: the pandemic forced individuals to isolate at home, but re-openings are causing increased migration back into the city, especially for workplaces. 

Students: with higher learning institutions open for on-campus learning, students are flocking back into the city, with heightened demand for student rentals beginning in May 2022. 

Immigration: the anticipated arrival of new immigrants as a result of border reopening’s and international turmoil will put increased pressure on the rental market, as this group generally relies on rental housing upon arrival. 

Its Consequence? 

Although unintentional, the consequence of this paradox is increased pressure on an already tight rental market. With future homeowner postponing purchase decisions, the turnover rate of higher-earning individuals in rental housing is lessening. This group, unwilling to purchase with current interest rates, is now in direct competition with students and immigrants, who oftentimes don’t have alternative housing options within the small pool of expensive Canadian real estate. 

The Solution: 

Government action at the federal, provincial and local government levels is required, and is key in solving the riddle in Canada’s current rental market. The basis of a solution is through government intervention to incentivize the construction of new purpose-built rental housing. Only through additional measures taken by regulatory bodies, such as lowering development costs and/or offering interest-free loans, will much needed purpose-built rental supply be generated to meet the demand.

Interested in learning more?

Access the Financial Post article here: