Concern has recently been raised in the United States and Canada about a growing crisis in rental housing. Since many of the issues raised in connection with the possibility of a U.S. crisis have surfaced earlier or in magnified form in Canada, this article examines the question of a rental housing crisis from the Canadian perspective. The article begins with a discussion of the background of the rental crisis and an examination of the pre-1972 tax preferences for rental housing. Evolution of the crisis is then analyzed, focusing on the 1972 restructuring of the tax system, expectations of accelerating inflation, government support for competing housing forms, and rent control. The impact of high interest rates on the decline in rental construction and changes in the socioeconomic composition of tenants and in the affordability of rental housing are also discussed. The article concludes with an analysis of the outlook for rental housing.
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References
1.
This increase is disputed by Kenneth T. Rosen, “The Affordability of Housing in 1980 and Beyond,”Center for Real Estate and Urban Economics Working Paper 80-10, Institute for Business and Economic Research, University of California, Berkeley, p. 11.
2.
2. This is probably overstated. The 1972 figure is from Michael A. Walker, “What Are the Facts?” in Rent Control a Popular Paradox, eds. F.A. Hayeket al. (Vancouver: Fraser Institute, 1975), p. 29. The 1980 figure is based on average head of household income in 1979 from the HIFE tape increased by 5 percent and compared to the average of all household rents for Apr. 1980, as supplied by the Canada Mortgage and Housing Corporation. Since households often have income in addition to that of the head, the 1980 ratio and hence the increase is overstated.
3.
3. U.S. General Accounting Office, Rental Housing: A National Problem that Needs Immediate Action, Report to the Congress by the Comptroller General, CED-80-11, 8 Nov. 1979.
4.
4. Elizabeth A. Roistacher, “Introduction,” in Rental Housing: Is There a Crisis? p. 10, and other articles in this volume.
5.
5. Although the conversion of rental apartments to condominiums is a major aspect of the U.S. market, it is of little significance in Canada and thus is not discussed in this article. The lack of such conversions may be explained in large part by federal and some provincial housing programs which heavily subsidized the construction of new low- and moderate-priced condominiums, making private condominium conversions relatively unattractive, and by widespread local by-laws prohibiting such conversions.
6.
6. For an elaboration of this, see Lawrence B. Smith, Anatomy of a Crisis: Canadian Housing Policy in the Seventies (Vancouver: Fraser Institute, 1977), p. 14.
7.
7. Lawrence B. Smith, Housing in Canada: Market Structure and Policy Performance (Ottawa: Canada Mortgage and Housing Corporation, 1971), p. 16.
8.
8. Ibid., p. 18.
9.
9. For a discussion of this shift, see Lawrence B. Smith, “Canadian Housing Policy in the Seventies,”Land Economics, 57(3):338-358 (Aug. 1981).
10.
10. The number of rental apartment completions is likely overestimated, since the final tenure form of some units could be changed before occupancy to condominium status.
11.
11. Offsets to the decline in user costs would occur if the fall in the price of houses generates expectations of future price declines and/or if the higher equilibrium demand for housing raises the mortgage yield/bond yield spread, reducing the decline in mortgage costs and the opportunity cost of homeowner equity.
12.
12. Other forces maintaining the high level of multiple rental starts include the long planning and preconstruction lags, rising inflationary expectations, and a low real mortgage rate.
13.
13. For a discussion of the relationship between vacancies and rents, and of the natural vacancy rate, see Lawrence B. Smith, “A Note on the Price Adjustment Mechanism for Rental Housing,”American Economic Review, 63(3):478-81 (June 1974).
14.
14. For example, the net change in the number of households in the 15-34 age bracket—the primary group for rental housing demand—declined from an annual average of 116,500 in 1971-76 to 90,100 in 1976-81 and is expected to fall to 62,100 in 1981-86.
15.
15. Government of Canada, Department of Finance, Government of Canada Tax Expenditure Accounts (Ottawa: Queen's Printer, 1979), p. 43.
16.
16. Ibid.
17.
17. However, it discouraged equity investment vis-à-vis debt investment because a higher proportion of the total yield in equities was in the form of capital gain.
18.
18. This representation is not strictly correct, since it is relative rather than absolute after-tax costs which fall as a result of the comparative gain in the investment aspect of homeownership arising from the increased tax on alternative assets.
19.
19. Other tax changes in the 1970s reinforced this. These changes included the introduction of Registered Home Ownership Savings Plans to encourage homeownership, and the capitalization for tax purposes of some development and carrying costs associated with real estate development.
20.
20. This is reflected in the indexation of the income tax in 1974.
21.
21. For a discussion of user costs and inflation in the tenure choice decision, see Douglas B. Diamond, Jr., “A Note on Inflation and Relative Tenure Prices,”Journal of the American Real Estate and Urban Economics Association, 6(3):438-50 (Winter 1978); Patric H. Hendershott, “Real User Costs and the Demand for Single-Family Housing,” in Brookings Papers on Economic Activity, 1980, 2, eds. W.C. Brainard and G.L. Perry (Washington, DC: Brookings Institution, 1981), pp. 401-44; Patric H. Hendershott and Sheng-Cheng Hu, “Inflation and Extraordinary Returns on Owner-Occupied Housing: Some Implications for Capital Allocation and Productivity Growth,” in House Prices and Inflation, eds. J.A. Tuccillo and K.E. Villani (Washington, DC: Urban Institute Press, 1981), pp. 11-33; and Harvey S. Rosen and Kenneth T. Rosen, “Federal Taxes and Homeownership: Evidence from Time Series,”Journal of Political Economy, 88(1):59-79 (Feb. 1980).
22.
22. This expression is simpler than the equivalent expression for the United States. The U.S. expression must recognize the tax deductibility of mortgage interest and property taxes, the taxability of capital gains subject to possible deferment via a home rollover, and the tax exemption on the first $125,000 of capital gain for persons over 55.
23.
23. For evidence of this in Canada, see Jack L. Carr and Lawrence B. Smith, “Money Supply, Interest Rates and the Yield Curve,”Journal of Money, Credit, and Banking, 4(3):582-594 (Aug. 1972); and Jack L. Carr, James E. Pesando, and Lawrence B. Smith, “Tax Effects, Price Expectations and the Nominal Rate of Interest,”Economic Inquiry, 14(2):259-269 (June 1976).
24.
24. This occurs since the sum of the mortgage and homeowner equity equals the value of the home. However, this ignores a number of effects, such as the tilt or cash-flow problem and possible increase in the variance in the expected house price inflation as inflation increases, which affect housing demand and may cause user costs to rise by restraining the actual and expected increase in house prices.
25.
25. The tilt problem arises from an increase in the anticipated inflation rate because increased inflation affects the level of interest rates but only the rate of change of household income. As a result, although increased inflation does not alter the present value of future mortgage payments, it changes the time profile of real mortgage payments, increasing the income-to-payment ratio in the early years and reducing it in later years. For a discussion of this effect, see James R. Kearl, “Inflation, Mortgages and Housing,”Journal of Political Economy, 87(5):1115-1138 (Oct. 1979); and Kenneth T. Rosen, “The Housing Crisis and the New Homeowners Incentive Plan,”Journal of the American Real Estate and Urban Economics Association, 5(3):366-378 (Fall 1977).
26.
and Yoram Weiss, “Capital Gains, Discriminatory Taxes and the Choice between Renting and Owning a House,”Journal of Public Economics, 10(1):45-56 (Feb. 1978).
27.
27. This conclusion is likely to hold even if mortgage costs are variable, since homeowner equity increases with inflation and the interest foregone on this equity is not taxed. The relative decline is larger if the tax system is not indexed and inflation causes the household to move through marginal tax brackets. In the United States, the benefit is further enhanced by the deductibility of mortgage interest and property taxes. Since these deductible items rise with inflation and the tax system is not indexed, the relative benefits of these deductions rise with inflation.
28.
and Canada Mortgage and Housing Corporation, Canadian Housing Statistics, 1981 (Ottawa: Canada Mortgage and Housing Corporation, 1981), p. 9.
29.
and George Fallis, Housing Programs and the Distribution of Income in Ontario (Toronto: University of Toronto Press for the Ontario Economic Council, 1980), pp. 58-103.
30.
30. A partial offset to this was the Assisted Rental Program (ARP) introduced in 1975, which provided interest-reducing loans for the construction of rent-controlled multiple rental dwellings.
31.
31. Similar loans were also made under ARP.
32.
32. For an analysis of this tax, see Lawrence B. Smith, “The Ontario Land Speculation Tax: An Analysis of an Unearned Increment Land Tax,”Land Economics, 55(1):1-12 (Feb. 1976).
33.
33. Actually, a form of rent control existed prior to 1975 in Quebec, and rent control was introduced in British Columbia and promised in Ontario in 1975 prior to the Anti-Inflation Program.
34.
34. Lawrence B. Smith and Peter Tomlinson, “Rent Controls in Ontario: Roofs or Ceilings?”Journal of the American Real Estate and Urban Economics Association, 9(1):93-114 (Summer 1981).
35.
35. An exception occurs if renovation or upgrading expenditures create an exemption from controls.
36.
36. Walker, “What Are the Facts?” p. 25.
37.
37. Based on an index of rental apartment expenses estimated by weighting the property tax, repair and maintenance, insurance, utility and fuel, and miscellaneous shelter cost components of the Consumer Price Index by .20, .10, .01, .12, and .05, respectively.
38.
and Larry Ozanne, “Expanding and Improving the CPI Rent Component,” in House Prices and Inflation, pp. 109-121.
39.
39. Smith and Tomlinson, “Rent Controls in Ontario,” pp. 93-114.
40.
40. Since the present value PV can be defined as [ILLEGIBLE] where Rj is the expected rent at the end of the jth period with no expected inflation, Sn is the residual or scrap value at the end of period n, i is the discount rate with no expected inflation, and ˙p is the expected inflation rate, it is clear that a change in the expected rate of inflation, if incorporated into both rents and the discount rate, will leave the present value unaffected.
41.
41. Inflation does, however, affect profitability and rental construction in other ways, as discussed in this article's section on increasing inflationary expectations.
42.
42. However, the nominal rate did rise sharply to 14.32 percent in 1980 and 18.15 percent in 1981.
43.
43. This impact, if any, would have been relatively small because of the relatively small increase in the nominal rate of interest in the 1970s, and because the tilt effect affects only cash flows and not expected profitability, and most Canadian developers had sufficient internal and/or external financing to be unconstrained by this.
44.
44. The shift to short-term variable-rate financing for homeowners should have some-what offset this by increasing the risks associated with homeownership and reducing household preferences for homeownership.
45.
and by Rosen, “The Affordability of Housing in 1980 and Beyond,” p. 10.
46.
46. Calculated from Canada Mortgage and Housing Corporation, Canadian Housing Statistics, 1981, pp. 74, 76.
47.
and Task Force on Canada Mortgage and Housing Corporation, Report on Canada Mortgage and Housing Corporation (Ottawa: Canada Mortgage and Housing Corporation, 1980), pp. 43-76.
48.
48. Based on appropriations for Public Housing, Federal-Provincial Housing, and Non-Profit Corporations and Cooperative Housing. If ARP is included, the decline is 78 percent.
49.
49. For an excellent discussion of rent controls, see Rent Control: Myths and Realities, eds. W. Block and E. Olsen (Vancouver: Fraser Institute, 1981).
50.
50. Philip W. Brown, “The Demographic Future: Impacts on the Demand for Housing in Canada, 1981-2001,” in Symposium on North American Housing Markets into the 21st Century, eds. G. Gau and M. Goldberg (Cambridge, MA: Ballinger Publishing, forthcoming).
