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During Canada’s “Housing Boom”, which ran roughly
6 I& J9 L& g+ nfrom 2002 to 2008, unsustainable price increases drove
) E" b5 _+ A3 o0 Cunsustainable levels of building. Our view is that house
9 v) s0 ~! o, Eprices exceeded the value of housing that was justified by
4 s5 j6 `2 }+ rfundamentals by approximately 9% nationwide. This* _8 \# j7 b; y: g2 V
overpricing compelled a level of residential construction
6 L& E9 d7 W$ ?that exceeded its fundamental-justified level by approximately
7 e; k/ e; q" L" Z0 x: i. h. ?12%, an excess that was exaggerated in the past9 j& Y3 I4 V' I# H5 @: w. o
three years." [5 G5 }7 {" B" D4 _
By “overpricing” we mean that prices detached from
' O! v. y, n! i" e6 gtheir fundamentals, as witnessed by a steep erosion of
5 A5 q9 W% S# S# \3 t. Haffordability. The current unwinding of house prices reflects" q6 K7 {; U) ^ B6 N
both a cyclical downturn and a return of house prices1 Z& ^9 Z- w5 A0 W
to fundamentally justified levels./ n- U) f6 O& A/ N1 _
We consider “overbuilding” of two forms: “demanddriven”
3 P4 ?% J. C6 [$ D/ G+ `where homebuyers buy up too many houses and
" B# H; a6 }: k! S1 [" pthat this demand cannot be sustained; and “supply-driven”- x0 f0 U& D1 y) s3 i$ r0 X
where builders accumulate excessive inventories. Although# l% b* y1 p8 J; U- q. |# v) W
there is evidence of both types, we contend that Canada’s
. ~. `( L$ @0 X“overbuilding” was mainly of the first type, where
! I* {1 E- O2 H& Ehomebuyers pushed homebuilding to an unsustainable pitch8 f! v ]6 |5 c( G
that is now being rapidly reined in.7 f- i2 [9 L+ S4 C7 K* c
While most markets won’t face U.S.-style overhangs,
5 u; q1 F2 E0 Y( n+ c8 k5 z8 ethe construction of too many new homes over the boom! L4 m' E1 _7 w; Y5 z
means a deepened slump. This overbuilding will likely weigh
- i5 K5 g2 J0 U4 |& fon markets over the next few years. Even as Canada recovers6 {) w1 [5 x$ A9 }" w p8 g" s
from the cyclical downturn, house price growth will, c, q4 u, K) e
remain choppy and new residential construction will be
3 b' u' L# V; e; p7 Y& edampened, owing to this structural weakness. Construction
1 V4 i' E1 b+ k2 r! Eis now undershooting fundamentals and we expect this) P! v* M5 o6 P
to persist over 2009 to 2011. We anticipate that nationwide
0 h: |9 {& ]+ A, x* Sresidential construction will fall further to around
8 q) C$ f" V* x/ h125,000 starts over 2009 with a trough around 115,000 units
5 o/ n5 C2 ^# R0 V& n& M7 Min the fourth quarter.
7 B, X- ^, ?. T5 oTo quantify the degree of overpricing and overbuilding,$ X' | g. W0 l O: f
we first develop an empirical model, based on long-run9 ]/ ~/ l# M. p$ m) K8 q
fundamentals of house prices and housing starts in each( p, A# N$ n4 U4 A
province. Affordability is the key concept behind home5 u, y! t0 r( k6 B
values since house prices should track incomes over the
1 V5 D \: v4 d: `8 y& klong-run. Since homebuilders build to meet demand, we* }3 Z/ ~8 v1 P* H. y/ }1 m, F
regard housing prices and household formation as the drivers; M: O7 {; }) h/ e% N
of residential construction." [" J& k) z. i% B4 U# a) `
To examine the degree of overbuilding, we employ a
! A! n- @% M% u5 z5 ^; ~4 w“counter-factual,” asking what level of residential construction
5 L' P/ H5 b7 @( Jwould have occurred if housing had been priced' ~9 e' c+ W8 u3 v* P# p9 T
optimally. We find that actual homebuilding exceeded this& k3 L- g* S4 ^7 O2 ^' g
fundamental-justified level by about 12%. Although new
y/ W1 ?8 ^3 T% A o2 kunits were being absorbed, homebuyers simply bought too$ [0 p2 `" w: q2 _; `& Z" x
many houses at prices that exceeded fundamentals.
5 c# G8 ?$ U# L& tRegionally, we see the greatest strains on the Prairies,
/ A0 u6 l9 [1 e! Q; r0 B0 S" L dwhere housing demand will further contract under waning* N3 V' w! B1 T* }
population inflows. Saskatoon, Calgary and Edmonton are
4 j' z1 _0 X9 V3 p" `" Balready witnessing surges in their unsold new homes at the
, T% D( N1 A% R7 Ivery time that the resale market has swung into strong$ F' h- r) D. `' U% I
buyers’ territory. Homebuilding in the Atlantic provinces+ {3 E I6 N- c1 O
has been relatively balanced but, while not plagued by structural" O9 D4 v) N$ R! @. t: T. k& x8 H
weakness, will be singed by the downturn nonetheless.& n; k+ L; H4 g
Québec shows signs of strain – especially given the
$ t5 W4 {6 q4 X3 ?strange accumulation of unabsorbed multiples on l’Île de$ W- @6 S2 v5 k, z) U
Montréal – but recent building has been relatively balanced,
; R1 ^4 |% U+ [- Z, L/ ?given the province’s history of under-building and low ownership4 C( e& h) W U5 D5 `
rates. While Ontario homebuilding will reel from a y8 n) ~! _3 r, y( h
cyclical downturn, the degree of structural weakness appears3 Y* T l) |9 n5 c& r O
limited – with the important exception of the Toronto
1 H K8 _. L3 n3 e$ Z; `condo market. Both in Toronto and Vancouver, historically
0 J, E0 q/ n4 t' yhigh levels of apartment-style units presently under/ x5 b5 `; C$ [7 Q; `$ K
construction mean that record numbers of condos will3 Z) d" |* v1 V* b( s: d% V
reach completion during 2009. If absorption rates fall, as
# r- w/ B2 B8 s/ B- xcyclical factors would indicate, condo inventories could2 t( b5 c7 Q2 h6 P& g7 f
spike severely – particularly in Vancouver. However, while" b, R& u1 _) ~
residential construction in B.C. will definitely droop, we
" O2 y8 b0 K7 D2 O' D* |anticipate that the West Coast will continue to benefit from- z0 ~; u; O; A8 Q6 l, h0 W
inter-provincial and international migration over the coming: I# ~5 x R1 g( O% M; _
years, which, along with improvements in affordability,0 P, [% c5 ~' O+ h; p- y
will alleviate some of the pressure from overbuilding., X$ R2 q* \, V6 U: p
OVERPRICED AND OVERBUILT: CANADIAN HOUSING0 S, D" |! O. [9 V" a* x
MARKET RETURNS TO FUNDAMENTALS
2 O9 I2 z& x+ y$ |* i; gGrant Bishop, Economist
v; ~8 Y2 `% Q" X5 g416-982-8063/ y4 Z, y2 ?' V
Pascal Gauthier, Economist
8 o) c! H' O& G4 Y; L1 E; l416-944-5730' M! }' y) }0 A( h
( R3 J) R0 H! ~' g8 B6 O2 jhttp://www.td.com/economics/special/gb0409_housing_exec.pdf |
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