^NewsWhy financialization of housing is a red herring

We recently wrote a blog (link), where we analyzed some potential findings regarding the impact of investment firms on rental housing. It spurred us to further review the topic and were surprised by the amount of academic literature and government focus on the topic of financialization of housing, so we wanted to take a closer look.

Introduction

First, a brief introduction to the concept of ‘financialization’ that appears to have taken over urban planning and urban geography departments around North America.

From the report for the federal housing advocate (link):

“Financialization is a process in which finance capital has come to dominate the economy and everyday life, and in which money is increasingly made through financial channels, rather than by making things (Krippner, 2004). Financialization is associated with growing social inequality worldwide (Piketty, 2014), and is connected to the rising influence of “neoliberal” ideologies and governance strategies. Neoliberal restructuring aims to prioritize the market and reduce the role of government in social redistribution. Financialization transforms practices of states, institutions, and society, in part through the mechanism of prioritizing “shareholder value” and other financial metrics. The structural prioritization of investor profits means that other objectives—including social, environmental, cultural, or other goals—are deprioritized by financial firms.”

And regarding financialization of housing:

“The financialization of housing refers to the growing dominance of financial actors in the housing sector, which is transforming the primary function of housing from a place to live into a financial asset and tool for investor profits. The financialization of housing is recognized as a trend that is undermining the realization of the right to adequate housing. The financialization of housing includes the securitization of mortgages and the direct acquisition of housing by financial entities that turn it into a product for investors. These entities include private equity firms, real estate operating companies, real estate investment trusts (REITs), asset managers, and institutional investors. Financial firms that invest in housing manage it for investors to produce maximum profits. In the industry, firms refer to “core,” “value-add,” and “opportunistic” investment strategies for real estate. For firms investing in rental apartments, a common strategy is to “reposition” buildings and “add value” for investors by driving up rental rates and other fees, cutting costs on staff and maintenance, and renovating common areas and vacant units. Profit-making strategies for financial firms investing in housing involve extracting more from residents, and often involve displacement.“

Generally it appears that those who write about financialization do not like markets-based economies and prefer government distribution of resources. When it comes to housing, they simply appear to describe investment activity that has happened for over 100 years – or more. The private sector has built housing, sold, owned and rented housing for as long as anyone can remember. Basic accounting identities will show that asset = liability + equity. Behind every property (asset), there is either liability or equity, that is capital. None of this is new yet it’s treated as if it’s an insidious new force in housing. Profit is also used as a derogatory term, that the author believes undermines housing. Yet it’s the opposite – without the profit motive, developers and rental operators wouldn’t take risks and strive to build and operate better housing. To be mad about profit is like being mad about having a trade deficit with your grocery store – or indeed, mad that your grocery store, café, and bar all make a profit off of you. Surely, making a loss by offering spoiled groceries or warm beer would be preferential?

Strangely, the authors portray renovation, modernization, and cost efficiency as negative outcomes. But improving buildings and operating them more efficiently benefits tenants and preserves housing stock. Raising costs or letting properties deteriorate benefits no one.

It reminds me of the ambiguously attributed quote, the following version from Milton Friedman:

“Milton recalled traveling to an Asian country in the 1960s and visiting a worksite where a new canal was being built. He was shocked to see that, instead of modern tractors and earth movers, the workers had shovels. He asked why there were so few machines. The government bureaucrat explained: “You don’t understand. This is a jobs program.” To which Milton replied: “Oh, I thought you were trying to build a canal. If it’s jobs you want, then you should give these workers spoons, not shovels.”

From <https://www.wsj.com/articles/SB124355131075164361> 

Attention to financialization at the federal government

Elsewhere, it appears the concept of financialization has caught the government of Canada’s attention. There have been parliamentary projects (link) and reports, CMHC studies (link), and lots of funding towards researchers on this topic.

A recent parliamentary report, or more specifically, the briefs submitted, provide a great amount of content on this topic. Some of the briefs provide a far better analysis of the topic than we ever could. We recommend Tsur Somerville’s submission which combines a contextual analysis of the concept of ‘financialization’ in housing itself, with logical explanations and evidence based research.

https://www.ourcommons.ca/Content/Committee/441/HUMA/Brief/BR12562272/br-external/SomervilleTsur-e.pdf

It’s only unfortunate that Prof. Somerville was only cited once in the entire report. Where as considerable more space was devoted to those who seem committed to advancing the narrative that ‘financialization’ or essentially more broadly free market investment in housing is bad.

Returning to the report on financialization for the federal housing advocates office, we reviewed the entire report to try to understand whether there’s a point made that’s backed by logic and evidence. However it reads as more of a description of basic business practices but simply written in a biased and critical manner. Essentially the framework can be summarized as follows:

1. Identify essential good, (and frame as human right)
2. Identify profit-seeking entities which operate to provide that good
3. Claim negative social impacts (without much evidence)
4. Blame deregulation, free markets, and capitalism
5. Propose state-centered solutions: limits, expropriation, government allocation of resources and price setting, and government ownership

You can apply this framework to education, healthcare, transportation, energy, groceries, etc.

This entire process appears to ignore anything to do with the provision of such goods, and the remarkable wealth and improved standards of living people around the world have had because of free markets, the private sector, and capitalism. It’s like that meme format:

1. Abolish private sector, markets, and capitalism
2. Government owns and operates everything
3. …..
4. Profit!

The authors appears to completely invalidate the choices of people in making market transactions, more specifically, of renters in choosing between trade offs of cost, location and quality of housing. That is, the authors want to complete ignore supply and demand. They seek to do so using the old Marxian concept of ‘use value’ vs ‘exchange value’. Where the authors claim use value, as a home, is more important than exchange value which is ‘financialization’. This falls apart upon closer scrutiny as even though we’re not economists, we can understand that the exchange value is set by the one who values the use the most and is willing to pay the most. For example, if a rental building is located near a hospital, those who work there — such as doctors, nurses, or technicians — may place a higher value on proximity, and willingly pay more to secure the unit. The price reflects this valuation of access, not some arbitrary financial manipulation. Different people may have different use values but only the one with the highest willingness to pay sets the exchange value and rents the home. This is a far more efficient allocation of housing resources than some arbitrary lottery, government allocation, or extensive waitlists. The authors appear to completely ignore that there is a diversity of incomes and preferences in our society.

This false dichotomy of ‘use’ vs ‘exchange’ value appears to simply be a way to put the authors values and preferences above those of others. In expressing the willingness of the author in limiting the freedom of others, they directly advocate for the expropriation of property if it’s owned by types of companies and in quantities the author does not like:

“3. Expropriate financialized housing in excess of reasonable minimums”  – Page 7

https://publications.gc.ca/collections/collection_2023/ccdp-chrc/HR34-7-2022-eng.pdf

Conclusion

In our review of this topic, we understand that primarily the advocates pushing ‘financialization’ do not like market based allocation of resources where there is the freedom of people to make housing choices based on factors such as location, price, quality etc. And where housing developers respond to differences in preferences by constructing housing that is both in demand and feasible to be built. Feasibility in building is important as if the value of the end product to users, as shown by the market price, does not justify the costs of constructing the housing – then such an endeavor would be a waste of resources. In a market based economy, developers who make poor resource allocation decisions soon run out of capital with which to deploy resources. Whereas those who are competent at constructing housing that meets the needs of the end users, efficiently, gain the opportunity to do more. We want this competition in housing operators and builders, competition that is driven by the profit motive.

We are also not advocating against the role of government. Some people will have trouble affording rents, and where possible, we think rental subsidies like the type provided by the German government to over 600,000 households is a great measure as this allows tenants to more freely move rather than be restricted to certain social housing projects or rent controlled units. These demand side subsidies help people clear the rent price floor – that is there are costs involved with operating housing: maintenance, property tax, insurance, utilities etc. For a 2 bedroom condo, this could easily be $1000-1500 per month in a major metropolitan city. But as mentioned, some may not be able to even afford this floor price. Hence the need for government subsidies. But to better help the majority of people, we need to build more housing supply. And this is where we lean more into what will likely be criticized as deregulation. But indeed, housing and property development is one of the most regulated sectors in Canada. Every policy maker with good intentions wants to and has added more requirements – that housing be environmentally friendly, good looking, large, accessible, centrally located, not cast any shadows, not block any views, be covered in trees, have both infinite parking and generate no traffic, be affordable and plentiful… and now there are activists who want housing to not be backed by ‘financialized’ entities i.e. your pension fund. This is completely unrealistic and counterproductive.

In making more housing available and for the market to better respond to demand changes, we will have to make trade-offs, invest in construction technology, improve our regulatory processes, and address affordability in economically coherent ways. The discourse regarding financialization, however, is ultimately a distraction. It focuses on who owns housing rather than how much housing exists, and whether people have choices. Attempts to eliminate ‘financialization’ are often thinly veiled opposition to markets themselves — replacing functioning private capital allocation with unrealistic demands for state-directed control over prices, production, ownership, and capital flows. This would not only fail to solve the housing issue but undermine the investment required to build the housing we need.