CMI monitors the latest developments and offers insights on solutions to Canada’s housing affordability crisis
Filtering refers to the decline in quality and price of properties over time, essentially explaining how housing units become more affordable as they age. Through this mechanism, new construction will tend to be occupied by higher-income groups at first, but successively filter (become accessible) to lower-income groups. Since new construction constitutes a small portion of the overall housing stock, filtering, not new construction, is the primary way the housing market generates affordable housing supply.
Filtering theory suggests that the most effective approach to improving housing affordability is to increase the construction of homes—of any type. However, affordable housing advocates argue that filtering either doesn’t work or works too slowly. Therefore, new development which could attract higher income residents should be avoided as it leads to gentrification. We see similar resistance from those who argue that we need to preserve low density character, protect view cones, or express other traditional not-in-my-back-yard concerns. (A view cone is an area where restrictions are set to ensure certain views – usually of landmarks, scenery, or significant structures – remain visible and unobstructed from particular vantage points.)
This confluence of oppositional camps has been a major deterrent to development. Yet most economists, potential home buyers, and renters would argue that creating new housing is essential to limit rising rents and home prices.
Most developers would say that filtering is obvious – add more supply in the market and it will benefit the entire housing spectrum. Proving it is more difficult. Still, there is solid research supporting the occurrence of filtering. For instance, Stuart Rosenthal’s 2014 study, titled “Are Private Markets and Filtering a Viable Source of Low-Income Housing? Estimates From a ‘Repeat Income’ Model,” along with the research of economist Evan Mast, demonstrate how the construction of new market-rate housing can influence lower-cost housing by causing a ripple effect that alters migration patterns of home buyers.
Filtering theory can help to explain why affordability is more problematic in housing markets that are inelastic (where demand for housing remains stable regardless of price changes and supply remains below demand). A 2021 research paper by the US Federal Home Loan Mortgage Corp. (FHLMC) found that regions with “elastic housing supply have faster downward filtering than the national average whereas markets with inelastic supply have upwards filtering on average.” (Downward filtering refers to new houses depreciating and becoming cheaper over time, while upward filtering refers to new homes appreciating over time and becoming more expensive.)
In the Canadian context, Calgary is an example of a market with an elastic supply, while Vancouver and Toronto are markets with inelastic supply. The FHLMC paper authors note that “[f]or inelastic areas, the higher than average house price growth translates to upward filtering. Thus, to the extent that the barriers to new supply are caused by restrictive land use and zoning regulations—such as limiting construction of single-family properties, imposing building height limits, requiring minimum lot sizes, or subjecting development to discretionary approval processes—then perhaps relaxing these restrictions would be an effective strategy for increasing affordable housing.”
Wharton’s real estate center produces a regulatory index for 2600 communities across the U.S. to capture the stringency of local regulatory environments. The FHLMC paper found that this index is positively correlated with their estimated filtering rates. Communities with high levels of regulatory restrictions on new construction tend to have upward filtering. This strongly suggests that markets such as Toronto and Vancouver need to be even more aggressive than cities like Calgary in fixing their regulatory framework to improve affordability.
CMHC has engaged Statistics Canada to conduct a survey on municipal land use and regulation. This initiative seems aimed at creating a Canadian version of Wharton’s regulatory index. It will be interesting to see if there are similar findings. The Wharton researchers discovered that regulation stringency was fairly consistent across all dimensions they evaluated. They didn’t observe communities targeting specific items or issues. Instead, cities tended to be more or less restrictive and utilized a wide array of regulatory tools to enforce their stance. Moreover, they found that the stringency of regulation was positively correlated to measures of community wealth but had a weak negative correlation with population density. This suggests that land use control isn’t primarily driven by scarcity concerns and that communities were not worried about running out of land.
While a Canadian regulatory index could help refine housing policy in coming years, the key takeaway from filtering theory is that any form of newly built housing improves affordability. Since development takes time, the sooner supply gets to the market the better, and the more supply added to the housing stock, even better still. Rather than debate what kind of housing gets built, the focus should be on building more housing and removing the barriers to doing so.
Independent Opinion
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