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During Canada’s “Housing Boom”, which ran roughly5 G5 V, X/ G: |7 j0 X. w2 j* r F
from 2002 to 2008, unsustainable price increases drove& ]6 @# X2 [, l+ v& s
unsustainable levels of building. Our view is that house
/ k9 F- t5 R, c1 z" i5 j% d: s, Cprices exceeded the value of housing that was justified by7 R0 p) i2 K. q
fundamentals by approximately 9% nationwide. This2 C2 J* A% O8 S r3 D! h
overpricing compelled a level of residential construction+ m& T) h( o3 f+ O/ ~/ h
that exceeded its fundamental-justified level by approximately# q: {- W6 z& A) H
12%, an excess that was exaggerated in the past
M$ X# i( c* Zthree years./ F& R& ^: i+ V
By “overpricing” we mean that prices detached from
; F/ k& ?% x a. m; \their fundamentals, as witnessed by a steep erosion of$ R( C$ h0 e6 N. N' V' g; R
affordability. The current unwinding of house prices reflects% G8 M d8 K5 J5 ^
both a cyclical downturn and a return of house prices
+ \6 W/ K1 Q2 k& Z1 f }. Jto fundamentally justified levels.1 ~, A+ h7 S2 o
We consider “overbuilding” of two forms: “demanddriven”
' Q7 G6 w# [% P/ y, g$ U- Awhere homebuyers buy up too many houses and
" d/ }& S9 n$ \2 u9 xthat this demand cannot be sustained; and “supply-driven”
# G+ D& h9 j/ o8 q8 K, Jwhere builders accumulate excessive inventories. Although
9 O- c" E5 G+ @: p. ^there is evidence of both types, we contend that Canada’s( V4 t/ }: Y& t: W
“overbuilding” was mainly of the first type, where1 V* h3 R: D1 D
homebuyers pushed homebuilding to an unsustainable pitch
6 a* B/ c' W5 n' Ethat is now being rapidly reined in.1 @# Y/ w9 D# F3 z9 O2 y
While most markets won’t face U.S.-style overhangs, O9 Z2 a R* p7 z* v3 e
the construction of too many new homes over the boom
- N" I6 H4 I9 a) p: Rmeans a deepened slump. This overbuilding will likely weigh( ?0 m4 {" S# D, f' X* ` Y8 U* b
on markets over the next few years. Even as Canada recovers& a2 F I. e6 O& B! E8 p! n2 I
from the cyclical downturn, house price growth will
: B9 V3 E" q5 \ Uremain choppy and new residential construction will be& \6 u* L7 D0 ~( o
dampened, owing to this structural weakness. Construction, C. m4 n6 W2 J/ q) A
is now undershooting fundamentals and we expect this
& Z1 Y) a- s7 C% ~5 B7 G Lto persist over 2009 to 2011. We anticipate that nationwide
8 k/ B1 t0 V1 g6 u8 Y. a+ k7 Wresidential construction will fall further to around1 q& y; o2 W6 g5 A: u
125,000 starts over 2009 with a trough around 115,000 units; {8 ]" Z4 O5 o) W5 L0 c
in the fourth quarter.; ^& R b1 X. h* ]. x) k
To quantify the degree of overpricing and overbuilding,, C) j2 n& P. @( t6 t1 b# Y/ C% W
we first develop an empirical model, based on long-run
' o& \& A) S- _+ q" Pfundamentals of house prices and housing starts in each
" U' Y# g) u: J3 y. r+ U- U" o& yprovince. Affordability is the key concept behind home
1 Z$ f' e- Q. V1 ^/ S3 N% pvalues since house prices should track incomes over the$ B/ d7 T! H5 ?. m: h+ A8 Q2 k# ^
long-run. Since homebuilders build to meet demand, we
* a1 M0 _! }9 R( a3 T; Kregard housing prices and household formation as the drivers
: X- ~- z. {( k; Z% q q4 N' Qof residential construction.6 x' b5 W& w& ]) J
To examine the degree of overbuilding, we employ a
" ~% ^' y4 a) M- I“counter-factual,” asking what level of residential construction/ D. B4 W1 Y, J) v2 V
would have occurred if housing had been priced9 @% r* K- p0 x' r/ {& u. d
optimally. We find that actual homebuilding exceeded this& T9 V3 ]3 A6 c, ]2 I
fundamental-justified level by about 12%. Although new
! h/ d/ x G7 D6 Punits were being absorbed, homebuyers simply bought too9 G J' {. f" u; \6 D9 a
many houses at prices that exceeded fundamentals.
: x' e5 w3 ]8 \4 G/ [) U# V cRegionally, we see the greatest strains on the Prairies,. o7 H$ v" c7 }* N0 n
where housing demand will further contract under waning
5 q3 F! M2 T. f3 m5 k, z8 h; Vpopulation inflows. Saskatoon, Calgary and Edmonton are8 U5 ^/ L3 }8 f8 k0 v
already witnessing surges in their unsold new homes at the
; P' \9 Z5 C" [3 A/ H; w I# }very time that the resale market has swung into strong9 r. C# x* R- T0 D0 q- z& s# f# f
buyers’ territory. Homebuilding in the Atlantic provinces# V- a T5 x% l
has been relatively balanced but, while not plagued by structural. a+ F( l, \! N; s0 I9 f
weakness, will be singed by the downturn nonetheless.6 k$ [; y1 \& S, L: S" ~8 h
Québec shows signs of strain – especially given the
" ?- l) G7 M! m8 C4 j7 g7 Q) a: H1 jstrange accumulation of unabsorbed multiples on l’Île de/ H6 k! Z0 Y D4 q+ @
Montréal – but recent building has been relatively balanced,
( n* ~ Q! N1 K0 `& _% f6 D1 s, wgiven the province’s history of under-building and low ownership* Z: P9 {6 j' ?
rates. While Ontario homebuilding will reel from a
& C5 ~' W3 d E' m& U P6 @5 p" i/ lcyclical downturn, the degree of structural weakness appears
/ k S" m$ I) l3 `& T* | w% s( Zlimited – with the important exception of the Toronto
# F, G9 B! ?( S! ?5 Z7 l$ ncondo market. Both in Toronto and Vancouver, historically
( l! a9 r- M# H0 h9 D! {# s( rhigh levels of apartment-style units presently under0 H0 K% x7 S! I0 Y
construction mean that record numbers of condos will
* {' `& V }* K$ u5 s$ Dreach completion during 2009. If absorption rates fall, as! W5 z/ M$ b0 R2 X6 Q2 D7 s/ u
cyclical factors would indicate, condo inventories could
! C( c. l, d8 z1 |spike severely – particularly in Vancouver. However, while
3 n# q0 v. v1 ]% c6 f. Rresidential construction in B.C. will definitely droop, we
# K3 C5 z) v, _. _/ X9 panticipate that the West Coast will continue to benefit from+ C4 J- o* B/ \: x4 y4 H, f' ]! L" d
inter-provincial and international migration over the coming3 V8 o2 j2 y& q8 v) q& z3 f* B
years, which, along with improvements in affordability,
* T6 p) n- L+ e1 `6 `: `' h- a6 Iwill alleviate some of the pressure from overbuilding.! E6 D2 X' L2 X& X& f" G1 n3 r
OVERPRICED AND OVERBUILT: CANADIAN HOUSING) e5 M) [& C) }; M4 m+ r
MARKET RETURNS TO FUNDAMENTALS& I5 b# U9 N( C; K. [! T: X
Grant Bishop, Economist; j3 `9 m8 f! A4 p
416-982-8063' ], l& y- k: Q' g/ h \
Pascal Gauthier, Economist9 z7 W% }; Z( P9 S# |" o
416-944-5730: L! {* i6 t) ]
0 T' O3 y# V8 |5 \
http://www.td.com/economics/special/gb0409_housing_exec.pdf |
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