Breaking down the costs of building new housing

To make housing more affordable, Canada needs to build more homes. Monetary policy plays an indirect role in increasing housing supply, but it is only one piece of a much larger puzzle.

Canada needs more housing

Just about everyone in Canada agrees we need to build more housing. In the late 2010s and early 2020s, population growth outpaced housing construction. That created a shortage of available housing, which pushed up prices for both homeowners and renters.

Many different costs are built into the price of new housing

Building large housing projects can be slow, complicated and expensive. Many different costs shape the final price of new housing, including:

• Construction materials. From lumber to windows to kitchen sinks, modern buildings require many different products and materials. Supply chain disruptions, fuel costs and tariffs can all cause these costs to rise.
• Labour. Architects, engineers, tradespeople and general labourers are all needed in large numbers to build housing at scale.
• Servicing. Developers pay to bring roads, power, water and sewer services to a building site.
• Permits and development fees. Local governments charge development fees to pay for the infrastructure that services new housing. They also issue building permits, which can require engineering reports and environmental assessments.
• Land. Every housing project needs land. Developers often buy and hold land for several years before any housing units are sold. During that time, they pay property taxes and incur maintenance costs.
• Developer profits. Companies that build housing are seeking a financial return. They bear the costs of building new housing with the hope that they will earn money by selling it, once a project is complete.
• Financing. Developers often borrow money to fund large construction projects. The Bank’s policy interest rate plays a role in determining the interest rates developers pay when they take out a loan. But the policy interest rate is only one of the factors that affect the rates developers pay. A company’s credit history and the viability of a project also play an important role—and bank loans aren’t the only way housing projects are funded.

How the cost of financing affects housing construction

Developers usually fund housing projects through a combination of their own funds, government financing programs, condo pre-sales and bank loans. When interest rates are high, borrowing money from a bank becomes more expensive. When interest rates are lower, borrowing is less costly. Changes to the policy interest rate can affect the size of the project a developer chooses to pursue, or whether the project goes ahead at all. But the policy interest rate isn’t the only factor developers consider when making these decisions—it’s one of many.

The policy interest rate affects both housing supply and demand

Strong demand to buy housing creates an incentive for developers to build new housing projects. Weak demand to buy new housing reduces the incentive to build more housing. And the level of demand responds to changes in the Bank’s policy interest rate because the rate affects how much it costs to take out a mortgage. Here’s how:

• When the Bank lowers the policy interest rate, short-term interest rates usually fall as well. That includes the prime rate which the banks use as the basis for variable-rate mortgages. And when the cost of a mortgage goes down, more people may be willing to take one out, which can push up housing demand and increase prices.
• When the Bank raises the policy interest rate, the reverse happens. Short-term interest rates rise, and the cost of having a mortgage goes up. Higher borrowing costs can make buying a home less affordable, which may lead to more people choosing to rent instead. When there is less demand to buy new housing, prices don’t rise as quickly, and developers have less incentive to build new housing.

Stable inflation helps housing projects stay on track

In the early 2020s, high inflation affected the entire economy, and it wasn’t just consumers that were affected. The prices of building materials and the cost of labour both went up, and the cost of building new housing went up as a result.

Large housing projects can take more than a decade to complete—and the costs are spread over many years. Whether a developer is planning to build luxury condos or affordable apartments, they need to be able to estimate their costs over the length of the project. Low, stable and predictable inflation helps them do that.

The Bank’s policy interest rate affects the entire economy—it does not target specific sectors of the economy such as housing or specific regions of the country. The Bank makes monetary policy for the Canadian economy as a whole. By ensuring that inflation is low, stable and predictable, the Bank can help give businesses and households the confidence they need to plan for multi-year projects, including building new housing.