Explore how some developers exploit supply & demand forces to maximize profits while depriving cities of housing. Part of our series “Causes of the Housing Crisis.”
At the northern edge of Toronto is a small, unassuming French restaurant, nestled between a gas station and a hair salon. A healthy combination of childhood nostalgia and genuine merit leads me to say that Le Montmartre restaurant has the best French onion soup I have ever had. While growing up I had many opportunities to enjoy this wonderful soup, and during my many visits, I would often see a set of dilapidated houses across the street staring back at me as a void from which no light or sound emanated.
In the darkness of the night, these empty downtrodden houses stand eerily quiet amidst the bustling activity that surrounds them. The driveway out front is cracked and overgrown with sprouting weeds and grass. Some of the windows are boarded up, graffiti can be seen on the outer walls. The decayed remnants of a wood fence that has long-since been breached fails to conceal the small forest growing in the backyard from onlookers on the street.
The houses sit at 924 and 936 Sheppard Avenue West in Toronto’s North York borough, although Torontonians would likely disparage me for calling North York a borough. The houses are flanked by 10 storey condos and a community centre. The street that the houses sit on is one of Toronto’s busiest arterial roads. For all 24 hours of the day TTC buses run by these empty houses, with many of their passengers going to and from the nearby Sheppard West subway station, situated not even 300 meters away.
Figure 1: The houses located at 924 and 936 Sheppard Ave W are located only 300 meters away from a subway entrance. Excellent walk score and transit score. Source: Google Earth.
The houses clearly benefit from a great location that is well connected for both transit riders and car drivers.
So why then have these houses sat empty for the past 15 years? Why do any single-family homes continue to exist intermingled among high-rise condos on this increasingly densifying and transit-connected intersection?
Figure 2: Historical satellite imagery shows that by September 2009 the houses were already boarded up and vacated. Exhibit A - Shrubbery and garden work removed since previous imagery from 2005. Exhibit B - Permanent garage structure demolished. Exhibit C - Wooden fence erected, no signs of activity on driveway such as cars which were observed in the imagery from 2005. Source: Google Earth.
Ownership documents for these two properties were sourced by FHA as part of our research. According to these documents, the properties in question have been jointly owned by a series of holding companies belonging to a local family since September 1988. This finding was corroborated after using business registry searches to confirm the names of the registered directors for the various holding companies that own these properties. The purpose of this article is not to unravel the ownership of this particular property, which is why FHA has chosen not to disclose the identities of the owners. The point being made, that is exemplified by these two dilapidated houses sitting empty for the past 15 or so years, is that developers can’t be trusted to build sufficient housing supply because it is in their interest to drive up demand at the expense of supply.
Developers can’t be trusted to build sufficient housing supply because it is in their interest to drive up demand at the expense of supply.
In a 2023 paper titled A housing supply absorption rate equation by Cameron Murray, the author tackles an interesting scenario: “you are a housing developer with a large plot of land on the fringes of a major city with no planning constraints. How quickly should you sell these lots to supply them to the housing market?”
The term used to describe the propensity of these developers to add new supply to the housing market is called the absorption rate. Stated another way, the absorption rate is the optimal per-period rate at which lots are turned into housing, whether that be as single-family homes, or via sub-dividing of the lot horizontally into multiple housing units or vertically into apartments.
Understanding the variables that directly influence the calculation of the absorption rate gives us a better understanding of why “rising prices make building today more attractive, but also make waiting more attractive, thus reducing the responsiveness to price,” as stated by Alvin Murphy in a 2018 paper titled A dynamic model of housing supply.
Equation 1: Murray’s housing supply absorption rate equation. This equation describes the decision-making of developers when deciding to convert land into housing. Source: Murray
Using Murray’s mathematical model, we can see ways in which landowners can be incentivized, or penalized, to be made more inclined to create housing today versus waiting the market out. This model gives insight into the possible thinking of the owners of 924 and 936 Sheppard Ave W, to help us understand why developers are incentivized to sit on vacant land rather than to turn it into much needed housing.
Absorption Rate Equation Visualized
Figure 3: Scenario 1 – Profit tomorrow, build housing tomorrow, because there is more demand (and thus profit) tomorrow, enough to justify the cost of waiting. Scenario 2 – Profit tomorrow, build housing tomorrow, because even if there is some demand today, it is better to wait and see where the market goes thanks to the low cost to sit on the land. Scenario 3 – Profit today, build housing today, because the demand is strong and the cost to wait is high.
A higher absorption rate means a greater rate of new housing supply created. Therefore, to achieve this outcome using equation 1, we aim to maximise the numerator while minimising the denominator. To improve the absoprtion rate, we can try and increase the housing demand, interest rate, and land value tax variables which define the numerator of our equation.
Naturally, if demand (dt) is sufficiently high, then it would be foolish not to sell (and thus create more housing) today. But with demand as high as it already is, especially in communities as accessible as where our two houses sit, it remains to be seen just how much more demand is needed before the owners of these properties can justify “cashing in” today.
Murray's strongest recommendation for improving the rate of new housing created is by way of increasing the cost of borrowing (i) and the land value tax rate (T) which in turn, would penalize developers who hold onto land by increasing the financial costs of doing so. The idea being that even if it is anticipated that a developer could sell tomorrow at a higher price, the total cost of taxes and borrowing needed to sustain the property over a longer period of time would negate those gains, thus compelling developers to sell more immediately.
Figure 4: Cities like Toronto are increasing the costs to sit and speculate on land via taxes such as the vacant home tax and the penalties on short-term rentals, which intends to compel more landowners to create housing either by renting out or selling their vacant units. Source: Travelweek. Toronto Star.
Improving the absorption rate may also be achieved by decreasing the price growth sensitivity and higher density variables. The price growth sensitivity variable (a) denotes how significantly each sale affects overall price growth in the broader real estate market. A larger a means that a single sale has a higher impact on price growth which would suggest a “thinner” market that has fewer transactions. Cities that have a high volume of real estate transactions such as Toronto already have low price sensitivity, in part due to the high volume of transactions, so there is little else to be done to optimise this variable.
The last variable we can manipulate to try and improve the absorption rate using Murray’s modelling is to decrease the w variable.
To better understand w and its implications let’s go back to those two empty houses in North York. Through the lens of the w variable, we find that a developer might be more inclined to build more housing when the perceived value of future density gains is lower. When the owners of 924 and 936 Sheppard Ave W originally bought the properties in 1988, the w variable was high because the probability that there could eventually be more density and thus, more value for these properties sometime in the future was high. And over the years, as a subway station was built nearby, and condo towers rose up around them, this assumption that the area would eventually densify and become more valuable proved true repeatedly, which translated into a higher w variable, and thus a lower absorption rate. The continuing growth and densification prospects for the area remains strong meaning the w variable for the two houses will remain high long into the future.
In fact, as recently as May of 2024 Toronto city council voted unanimously to approve a community development plan for the former site of the sprawling Downsview airport, which may see the airport transformed into a 370-acre mixed-use community being called the largest active urban redevelopment project (by square area) in North America today. The edge of this future development is only 500 meters away from our empty houses on Sheppard Ave W. This translates into a w that will continue to be high, which means that the calculated absorption rate is lowered, because the incentive to wait and see how much more valuable the land may become in the future is worth delaying housing development for. Although selling today would contribute badly needed housing amid a historic housing crisis, the fact remains that with the perceived future pay-off for these properties remaining high, it is unlikely that we will see any new housing introduced to these vacant lots anytime soon.
"Investment should be delayed when growth is high.” - Lange & Tuellings The option value of vacant land and the optimal timing of city extensions
Murray’s model shows us how the motivations of developers are largely driven by quantitative market factors. But more than that, Murray’s math shows us that the observed behaviour of developers embodies the same volatility and speculative action that can be seen in any other asset trading market. Which may seem like an obvious point to make, but it’s important to remember whereas stock trading does have serious implications for the wealth planning of the rich and poor alike, that a house unlike a stock represents a fundamental human need that is crucial to the livelihood and proper functioning of a civilized society. Humans can arguably live without exchange traded securities, but without argument a person cannot live without a home, or at least, not for long.
To exploit and financialize housing writ-at-large in the same way as any other financial instrument jeopardizes the housing security of millions of Canadians. The logical continuation of these trends if left unabated can be characterised by something I call "the housing cycle of doom."
Figure 5: The housing cycle of doom
The unique relationship housing has on individual people (as a means of shelter and as a means of storing wealth) and on the macro-economy as-a-whole (as an economic indicator and as a fundamental need for every person) sets the conditions for the exploitation of housing and for the creation of an endless cycle that will continue to compound the issue of housing affordability and availability. If there is to be a future of more affordable housing in Canada, it is crucial that we break the housing cycle of doom.
With respect to housing, supply and demand is unable to achieve a stable equilibream thanks to the meddling and profit motives of speculative developers. No sooner than when the incentives to delay housing development are eroded can a more stable and affordable market equilibream be achieved. Through the analysis of Murray’s mathematical framework, we can see how by making it more expensive to sit and speculate on land, we improve the conditions for more immediate housing development among other, albeit less realistic ways of improving the absorption rate.
Through the visual of the housing cycle of doom, we see other ways in which it might be possible to break the cycle and to restore housing affordability & availability. We discuss this further in other FHA articles such as a past article on the topic of market competition in the residential construction industry titled The (not so) free market: How a non-competitive home builder market creates less affordable housing.
Written by Michael Clement Cambare
Michael is a co-founder of FHA. A passionate affordable housing advocate and someone very frustrated with the state of housing in Canada.