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During Canada’s “Housing Boom”, which ran roughly
" N' M5 I$ l: f7 s; Ufrom 2002 to 2008, unsustainable price increases drove+ m8 T( E2 y" B5 P
unsustainable levels of building. Our view is that house
- o. `& N) K) Xprices exceeded the value of housing that was justified by
" b2 A& z, A/ f' ~2 E9 v) ?fundamentals by approximately 9% nationwide. This
/ m$ e4 J, s5 i6 Z; T3 koverpricing compelled a level of residential construction
; B. g( }9 e7 p8 C; x! zthat exceeded its fundamental-justified level by approximately7 E$ `) e# d3 V) I4 G' o O! Z
12%, an excess that was exaggerated in the past# M& m1 u+ O3 n l, S: q- r
three years.7 T& x# H7 ]/ K+ D2 V1 |5 L
By “overpricing” we mean that prices detached from9 W5 h* r0 z# p$ b) {/ _8 p
their fundamentals, as witnessed by a steep erosion of+ C U& Y1 G' v" w$ T+ Y
affordability. The current unwinding of house prices reflects
( z C* X* m9 t0 A/ eboth a cyclical downturn and a return of house prices
3 @7 P) Y% p( q: A$ v& }" c- O2 _to fundamentally justified levels.
( q0 L/ |7 o; ?0 r9 kWe consider “overbuilding” of two forms: “demanddriven”
7 h( H+ E) p% W. B7 R9 Gwhere homebuyers buy up too many houses and1 ~9 L2 F% ^% C( m+ O
that this demand cannot be sustained; and “supply-driven”' ?1 D( W& H$ b {
where builders accumulate excessive inventories. Although, E- O+ K, t0 G
there is evidence of both types, we contend that Canada’s" K; G5 S6 F! r+ t: c; L( l; i3 |+ J
“overbuilding” was mainly of the first type, where L. y g7 h$ {; Y- b6 A0 _& [
homebuyers pushed homebuilding to an unsustainable pitch
2 ]0 i; `( j9 h5 b5 Lthat is now being rapidly reined in.+ z5 y) ?- Z2 j# W+ x5 B. {8 x
While most markets won’t face U.S.-style overhangs,# G7 e; h* O2 E
the construction of too many new homes over the boom
( x+ R7 F/ U) U \' s( V; Dmeans a deepened slump. This overbuilding will likely weigh
9 {1 l/ D/ G4 z' Ron markets over the next few years. Even as Canada recovers
1 D6 F6 b: w# W3 t r- g8 @from the cyclical downturn, house price growth will/ u% v) `- U7 P( k( E
remain choppy and new residential construction will be
& [) U3 g) ]5 y* ?9 x! rdampened, owing to this structural weakness. Construction
5 {' ]' x+ c% X# iis now undershooting fundamentals and we expect this y1 `$ v/ y8 M, o ^
to persist over 2009 to 2011. We anticipate that nationwide. h( Z4 f1 _0 @8 n- W( R' f
residential construction will fall further to around
% W$ U4 G5 w8 @/ y7 O, i/ [125,000 starts over 2009 with a trough around 115,000 units
& B7 b% A4 d3 Q3 uin the fourth quarter.
: m! H/ F. H) MTo quantify the degree of overpricing and overbuilding,- j% ~: `# C& Y: t
we first develop an empirical model, based on long-run) a' x6 k. }/ _0 k
fundamentals of house prices and housing starts in each" @4 }) F" U6 m" r# n; U% @- h! s
province. Affordability is the key concept behind home& ^8 u$ @+ k! f
values since house prices should track incomes over the* n4 ~ _) b: B" `- O& j
long-run. Since homebuilders build to meet demand, we
7 V7 [5 u! k( A* N) |3 D" Sregard housing prices and household formation as the drivers
8 a( j6 {& M+ _. hof residential construction.' O: z& x0 L: m' `$ x
To examine the degree of overbuilding, we employ a. `; c( m6 v6 w! P4 E+ Q
“counter-factual,” asking what level of residential construction
% `% ^+ A/ c$ B" Qwould have occurred if housing had been priced
0 Y1 J; y1 u5 N8 l+ k! _optimally. We find that actual homebuilding exceeded this+ Y9 ?3 f: P' Y2 b1 U5 R
fundamental-justified level by about 12%. Although new5 m. J% y$ Z1 P: y% D: e) v
units were being absorbed, homebuyers simply bought too ~$ }/ B! o: P2 b
many houses at prices that exceeded fundamentals.% W0 b3 |' K( g& c5 X' t L6 Q. L
Regionally, we see the greatest strains on the Prairies,
0 Y0 e9 R6 G7 U( j! O4 Swhere housing demand will further contract under waning
$ C. D4 y" ?7 G0 X( Dpopulation inflows. Saskatoon, Calgary and Edmonton are
@) z& m; }4 W0 S8 lalready witnessing surges in their unsold new homes at the5 ~' F$ {' ?4 x
very time that the resale market has swung into strong
; g' p5 Y8 h8 ^/ @$ n" sbuyers’ territory. Homebuilding in the Atlantic provinces
& H2 V* W$ @+ e8 R: Thas been relatively balanced but, while not plagued by structural2 M. C' o! r/ q
weakness, will be singed by the downturn nonetheless.
. W- K# I8 h+ C0 ^- PQuébec shows signs of strain – especially given the7 r; V0 Y* }- R+ M$ `
strange accumulation of unabsorbed multiples on l’Île de% a' T1 D" l: s( |* L' W C. J2 n
Montréal – but recent building has been relatively balanced,! t" G# E* M! S% q
given the province’s history of under-building and low ownership) o* A# k& L# E" t. K
rates. While Ontario homebuilding will reel from a
4 f+ M! ~+ A3 F. S, n) `7 Ocyclical downturn, the degree of structural weakness appears$ j2 y1 W. ]! c0 }% m
limited – with the important exception of the Toronto5 T5 h5 m% W+ d; g( e3 C
condo market. Both in Toronto and Vancouver, historically
2 k' x. f! t' n G7 X4 Mhigh levels of apartment-style units presently under i2 a: I# n% u
construction mean that record numbers of condos will. z# S+ k; Q+ T
reach completion during 2009. If absorption rates fall, as$ W _9 W. C1 G7 c0 S
cyclical factors would indicate, condo inventories could4 g! b+ L4 h% f& {0 X! Z% n
spike severely – particularly in Vancouver. However, while
& l1 L+ {4 j' s. ~' oresidential construction in B.C. will definitely droop, we1 N; V# @4 u) C2 g ]/ c& N# X, A
anticipate that the West Coast will continue to benefit from& a- _2 E) j, I6 J, m5 f1 G
inter-provincial and international migration over the coming% j0 {/ t6 ?) Q) ?1 b( \
years, which, along with improvements in affordability,0 d5 }* r5 ~0 D; ]1 J
will alleviate some of the pressure from overbuilding.
- x' v8 c! }) t1 m& HOVERPRICED AND OVERBUILT: CANADIAN HOUSING1 b1 z, @7 f. i9 O
MARKET RETURNS TO FUNDAMENTALS) h/ y9 t* x6 @. C! D( E8 \! K o
Grant Bishop, Economist
4 c/ t/ t1 \. J |& X+ G, e, |416-982-8063
, [7 L7 m. ~) APascal Gauthier, Economist
6 m4 P' O& L) B$ z416-944-5730
2 y* |3 S5 l% n5 U' y5 h, x. C7 G- w+ \/ Z$ G, h
http://www.td.com/economics/special/gb0409_housing_exec.pdf |
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