The evidence is building that Canada's housing markets — particularly Toronto and Vancouver — are going out of whack. "No duh," you say, "you noticed prices soaring insanely too, huh?" Well it's not just that. It's that these housing markets seem to be violating some basic economic principles. There's a lot going on that doesn't make sense, at least on the surface. But first, let's start with some context. Here's what's going on with the supply of housing and home affordability these days. Canada has never built so many condos...

Condo construction has reached a record high in Canada of 5.8 units per 1,000 people. "Strictly speaking, this level is well into the ‘high risk zone’," says a report from Royal Bank of Canada, which produced this and many other charts in this article. But RBC isn't too worried, because it sees a shortage of housing in Toronto and Vancouver, where much of this construction is concentrated. ...While single-family home construction is near record lows

Construction of single-family homes is at multi-year lows, a phenomenon largely blamed on a lack of space in Toronto and Vancouver. "In some of Canada’s largest markets, demand for single family homes significantly outstrips supply," RBC says, which may help explain why single-family home prices have risen much faster than condo prices. But is there really such a huge demand for housing in these cities? Some charts below suggest otherwise. But first let's take a look at affordability. Toronto's home affordability is the worst it's been in a quarter century...

Toronto homes haven't been this unaffordable since the early 1990s, when a housing bubble was bursting in the region. That bubble has been blamed on two things: The Bank of Canada sharply raising interest rates to fight inflation, and a sudden drop in the number of people in home-buying age around 1989/1990. Today, affordability is equally bad, but with much lower mortgage rates. An increase in mortgage rates would put many households in a financial hole. But Toronto's population growth is as strong as ever, so demand is growing, right? Maybe not. More on this later. ...While Vancouver's affordability is the worst on record

Home affordability in the Vancouver region is even worse than in Toronto, and hit its most unaffordable levels ever recorded in 2016. There's been heated debate about the degree to which foreign buyers are responsible; the chart below suggests they have to be responsible for a good part of it. West Vancouver house prices jumped more than 50% as its population fell

Sources: Real Estate Board of Greater Vancouver, BC Statistics. That's right. The tony city of West Vancouver lost about 2,000 residents between 2011 and 2016, a decrease of about 5 per cent. In that time, the city's benchmark house price rose from around $1.5 million to just under $2.5 million. Logic dictates that a city that's losing population should be seeing falling or stagnant house prices. Unless, of course, the demand for housing is coming from people who don't live there — foreign investors and house-flippers. It costs five times as much to upgrade from a Toronto condo to a house as it did five years ago

As recently as 2011, the gap between the average-priced newly-built condo and the average-priced new detached home was less than $100,000 — an affordable mortgage for most upgraders. By 2016, the gap had increased to some $500,000. It now costs more to upgrade from a Toronto condo to a house than it did just to buy a house five years ago. But of course, this is all driven by real demand, right? Everybody wants a backyard, and everybody has tons of money, right? Well... House prices rose rapidly even when there was more supply than usual

Between 2010 and 2015, the supply of homes for sale across Canada was higher than the long-run average, and by a good bit. Despite that, the average house price — as measured by the MLS Home Price Index — rose 28 per cent, much faster than inflation or wages. What did change in that time is mortgage rates — they dropped to record lows. This suggests that what drives prices is not demand for housing, but how much banks are willing to lend. Which makes sense, when you think about it. There are fewer people around to buy Toronto homes than usual

One of the arguments commonly made for why Toronto suffered a seven-year-long housing bust in the 1990s is that the growth in the population of homebuying-aged people shrank considerably, due to demographic shifts. Well it appears one of those demographic shifts is taking place right now, with Toronto's adult population growing more slowly than just a few years ago, and below the average rate. But this slowing growth coincided with acceleration in house prices. So where is demand coming from in Toronto? It would seem not from people who actually need to live in the homes they're buying. Toronto home construction plummeted during the Great Recession. Toronto recovered, home construction didn't.

The financial crisis of 2008-09 caused developers to pull back big-time on housing construction. Then the Bank of Canada dropped interest rates through the floor and people were being offered 3-per-cent mortgages, and Toronto's home sales and prices recovered quickly. But what didn't recover at all? Home construction. It plunged and stayed down. Since it's unlikely that Ontario's anti-sprawl rules started to have an effect at the very moment the Great Recession happened, it's possible that developers and/or land speculators are sitting on available land in order to drive up prices. Some market observers have suggested this is happening. Montreal has the same housing "shortage" as Toronto. So why aren't Montreal house prices soaring?

This might be the nail in the coffin of the argument that house prices are soaring because of strong demand and low supply. If that were true, then Montreal would be seeing the same crazy house price growth as Toronto -- because Montreal is experiencing a very similar decline in its new home supply. But affordability in Montreal is at its long-term average:

And the argument that Toronto's population is growing much faster than Montreal's doesn't wash here — those new home numbers are on a per capita basis, meaning they're adjusted to account for population change. And given that Montreal is a job-creating powerhouse these days, you'd think people would have the money. Something other than supply and demand is driving up prices in Toronto. Market psychology, maybe? Vancouver and Toronto are more expensive than Paris, New York and Tokyo