Brave New World – Population Decline, the Canada Pension Plan, and Housing

Recent headlines about population decline has started me thinking about the effects a declining population might have on Canada.

The Decline of Empires

I didn’t spend much time in History classes in high school and beyond.  I slowly allow my knowledge of history to expand as I read articles that reference the past to frame today’s world.  I also take in stories from my friend John who grew up under a communist regime in Hungary.  So, with this background you will forgive me if I don’t have the wisdom of the ages and that I am simply guessing about the future as a mathematician.

Japan is the country that I first heard had declining population.  I am not sure when I heard that, but it was well before 2010, which is when it started to occur.  Japan’s fertility rate has been dropping since the 1970s and they aren’t a country known for robust immigration, so this outcome seemed to be inevitable.

By comparison, in 2021, Canada recorded 368,000 live births with a comparable 405,000 new immigrants.  What Canada fails to achieve in the delivery room we make up for at our ports of entry.  Some people form judgments about the positive and negative effects that immigrants have on Canada.  My only observation is that you can find both individuals that are born in Canada and immigrants to Canada that are hardworking law-abiding citizens and likewise you can find individuals from both groups that are a negative to our society.  I think trying to label immigrants with a single stereotype is futile.

The Canada Pension Plan

I don’t know if I have ever referred to the CPP as a Ponzi scheme – but some have.  In truth it is a semi-Ponzi scheme.  But the scheme is going to work for two reasons.  First, you don’t get an incredible return on your money financed by the next generation of suckers.  You are already the sucker financing in part the first generation that got full benefits after contributing for only 10 years.  Second, there is a guaranteed inflow of new contributors.  While some Canadians work ‘under the table’, the majority collect T4 income and contribute to the CPP (or QPP).  

Canada’s government has long figured out that the sustainability for CPP and the fiscal deficits that they regularly operate is to make sure that we have future workers to replace those that are retiring so that they can be taxed.  Immigration is the noted balancing feature and Canada continues to grow – not shrink.  On June 16, 2023, Statistics Canada reported that there were 40 million Canadians.  Actuaries for the CPP and QPP estimate that by 2100 the population will exceed 50 million.  Those waiting for population decline in Canada have some waiting to do.

If you have read my past blogs on CPP, the most recent here, you know that I am not worried at all about the sustainability of the CPP.  On the other hand, as my now adult children try to find a way out of the nest to their own home, I grow increasingly concerned about the affordability of homes for young adults and newcomers to the country. 

The Future of Housing

When I first started working in Toronto in 1986, I was talking to a guy who worked in my building that was probably in his mid-20s.  He had leveraged everything he owned and every cent of his income to buy a home that he was renting out.  He was convinced that housing would always go up in price and that leverage was the way to build wealth.  In a future commentary I will talk about the risks inherent in this theory. 

Although we had a setback in real estate in the first half of the 1990s, overall the house this guy bought for around $300k would be worth more than a million today and he would be able boast a ‘miraculous’ return on his investment over the nearly 40 years that have elapsed.  But before we get ‘housing envy’ I want to remind you that the $300k is really $750k in today’s dollars when you adjust for inflation and from an investment return perspective, quadrupling your money over 37 years is a return of less than 4% per annum – and that is before you consider taxes and maintenance expenses incurred on the journey.  The silver lining for housing in Canada is that the net gain is not taxed if it is a primary residence.  This helps improve the comparable investment return of housing but hardly makes housing the road to wealth that the media portrays.

Setting aside the investment thesis, we all need a place to live.  In my youth I was sure housing prices would fall as all the baby boomers downsized and scrambled to find someone from the ‘baby bust’ generations that followed their generation to buy their home.  We now know that didn’t happen, although it isn’t perfectly clear why not.  There seems to be two key contributing factors.  First, boomers are not selling the home in which they live, even though the house is often way too big for their empty nester lifestyle.  Boomers that built wealth through home ownership AND saved for retirement at the same time find themselves in the enviable position of not needing to sell their home to support a comfortable standard of living.  These homeowners like where they live and for many of them, there are good memories of a life well lived and neighbors sharing the same history for 40, 50 or even 60 years, so the increased supply of houses is not coming online as soon as I expected.  Second, the baby bust generation is being augmented with the immigration already mentioned, so the demand for houses isn’t shrinking as I predicted.

One thing first time homebuyers will need to think about is that what we demand in a house today (granite counters, inground sprinklers, 3+ bathrooms) were luxuries in the 1960s and just may not be affordable to the masses.  Around the corner from me, builders are taking over farmland and building full streets of houses that cost $2 million (4000+ sf, granite and tile everywhere, every bedroom gets its own bathroom).  That may not sound like a lot of money to my readers in Toronto or Vancouver, but this is Windsor where 10 years ago the only houses over $2 million were on the waterfront.

I continue to wonder who is buying these houses, how leveraged they are with a large mortgage, and if the entire house of cards will collapse one day?  At the same time, I monitor the cost to build houses and read about the endless opportunities from someone entering the trades.  Housing demand rising with new children and immigrants and supply growing slowly with zoning hurdles and a lack of trade workers does not sound like a formula from Econ 101 for falling prices.

Brave New World

One thing that is hard to measure is the real cost of housing.  We talk in nominal prices which should always be expected to rise with inflation.  When financing a house with a mortgage, what matters more than the interest rate you are paying is the real interest rate net of inflation.  In a world like today where interest rates and inflation are close to the same number – the real interest rate is close to zero.  This makes housing more affordable than periods where inflation is low and interest rates are high.  In the end, housing prices will constantly react to ‘supply and demand’ and part of the demand is the real cost of borrowing money.

Where is this headed?  I have several theories on how this will play out:

  1. Slowly home buyers will rely less on the ‘prices always go up thesis’ and will buy smaller houses that are more affordable and provide something closer to the necessities of life.
  2. As buyer sensibility slows the buying mania, housing prices may not decline but at a minimum prices will rise more slowly and maybe even stagnate for a decade to allow for wages to catch up to housing costs.
  3. There will be a rise in multi-generation homes with kids staying at home longer and grandparents sharing the load of either domestic duties or sharing the mortgage if they are still employed.

These are all ideas about reducing demand or at least the upward pressure on prices.  Governments often talk about increasing supply but when I look at the cost to build new homes, I am not sure new AFFORDABLE supply is on the way anytime soon.

I routinely tell my kids that they are living during the best time in human history in one of the best countries in the world.  This doesn’t mean that they don’t aspire to improving their standard of living – but it does mean that maybe we have reached a point of peak living standards and that future generations are going to have to accept more modest housing in either size, quality, or the number of roommates.

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