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During Canada’s “Housing Boom”, which ran roughly2 _8 q0 F/ x% p# H6 Q/ x9 d* b3 N* U
from 2002 to 2008, unsustainable price increases drove
7 O" [+ Y5 J0 y# M Y6 k, runsustainable levels of building. Our view is that house
! z1 _. Z: g4 [& d) |) Tprices exceeded the value of housing that was justified by
+ f. ~/ V* R3 C, Kfundamentals by approximately 9% nationwide. This: q, l1 e* t* d+ N, Y. u% z, V
overpricing compelled a level of residential construction% S/ ?$ d9 w) d# e, V3 b
that exceeded its fundamental-justified level by approximately
6 }8 }4 R; [: w$ G% H3 F12%, an excess that was exaggerated in the past
, J# ?. i$ h( t$ A: `three years.
% b: }: O% c4 A2 _1 c8 o* CBy “overpricing” we mean that prices detached from% M7 q2 z4 z7 S8 T$ K, R+ s
their fundamentals, as witnessed by a steep erosion of5 F* b2 H: ^5 T8 n2 [" E9 B2 Z2 s
affordability. The current unwinding of house prices reflects
& Z% z6 V& I8 S% l# ]both a cyclical downturn and a return of house prices
9 J9 L x8 i+ A9 u1 wto fundamentally justified levels.
' ?2 I3 v9 X6 |% X% f$ t# Q! L; |We consider “overbuilding” of two forms: “demanddriven”7 S$ b/ T$ _, q: {' W
where homebuyers buy up too many houses and% E4 N& ?! G+ U# J
that this demand cannot be sustained; and “supply-driven”+ p0 ~% p. ]( D& Z7 b7 X
where builders accumulate excessive inventories. Although: | d0 m6 }1 k7 @8 o6 V4 k
there is evidence of both types, we contend that Canada’s6 t7 t5 g T7 H. ^9 i! i
“overbuilding” was mainly of the first type, where
8 U& N. x' U" E1 @, i$ x& `homebuyers pushed homebuilding to an unsustainable pitch+ o9 ]% D$ y, `- u9 z# B' T
that is now being rapidly reined in., M2 ?+ o/ a$ }: S( @1 i! {
While most markets won’t face U.S.-style overhangs,
) A: ]7 W; }0 |0 O3 e6 kthe construction of too many new homes over the boom: y1 f1 ]( M/ n& l# E9 s) ^; @6 S
means a deepened slump. This overbuilding will likely weigh2 W7 }# V+ Q G1 `2 R2 x7 t4 }
on markets over the next few years. Even as Canada recovers
- D; c4 z+ V- d( m# _from the cyclical downturn, house price growth will; N, @8 a) {9 |' l
remain choppy and new residential construction will be. O+ [; y( F# i& H) t0 n
dampened, owing to this structural weakness. Construction
- K6 v4 Y. M- i# y/ Nis now undershooting fundamentals and we expect this- d2 o1 `1 n" [1 t2 r2 p; m% y
to persist over 2009 to 2011. We anticipate that nationwide/ n l! Y! W5 E/ |) G: A
residential construction will fall further to around
5 P% p. ~. g3 [! e K8 ]125,000 starts over 2009 with a trough around 115,000 units
& a$ h6 L* w" i% R# O5 [in the fourth quarter./ y0 y" O! V$ H. g" h( _
To quantify the degree of overpricing and overbuilding,
$ l1 v8 L: G; |we first develop an empirical model, based on long-run" ~9 Q! j H& `
fundamentals of house prices and housing starts in each
; ]4 D$ A! I( P p( tprovince. Affordability is the key concept behind home- \; ]6 _; E' \' R/ q6 r
values since house prices should track incomes over the# g* \! \; X, L% d* {5 j
long-run. Since homebuilders build to meet demand, we( a, S% B5 e7 L! B
regard housing prices and household formation as the drivers
8 ?! b$ L* Y8 d4 m: wof residential construction.6 U' G& a A8 u3 y' U+ G; B
To examine the degree of overbuilding, we employ a
Q8 @% T. _! _, e! Z“counter-factual,” asking what level of residential construction. o4 e* X/ j- h
would have occurred if housing had been priced
1 N0 y1 O8 X; T/ @6 H4 Eoptimally. We find that actual homebuilding exceeded this1 \& a# r U0 [4 {2 ^8 {; N* T
fundamental-justified level by about 12%. Although new0 c/ K! p8 A7 n7 _0 a- `! Q9 A8 H
units were being absorbed, homebuyers simply bought too
$ S: R# R) ], U- Mmany houses at prices that exceeded fundamentals.3 R, I; h) a' J5 I* q: s
Regionally, we see the greatest strains on the Prairies,
! ~6 A$ m+ R! L+ S4 G, V4 e8 z. {where housing demand will further contract under waning
; c4 t' v7 `9 q$ @: O+ l, C# ipopulation inflows. Saskatoon, Calgary and Edmonton are; J+ t# J y3 ^
already witnessing surges in their unsold new homes at the
, e0 O, x. o* ~7 _' z qvery time that the resale market has swung into strong
/ R3 m/ Q" w& R& ^buyers’ territory. Homebuilding in the Atlantic provinces0 U; ?& f! d( Y
has been relatively balanced but, while not plagued by structural
9 o' p9 g9 J6 ]3 lweakness, will be singed by the downturn nonetheless.
6 B+ m/ Z: a Q/ y: ~- O! ^Québec shows signs of strain – especially given the) s8 h- M, k1 n
strange accumulation of unabsorbed multiples on l’Île de
7 W* I- N# W. ^Montréal – but recent building has been relatively balanced,# t# R/ R/ R H% L; [
given the province’s history of under-building and low ownership( e5 ]3 d+ t5 m2 d8 }) ?
rates. While Ontario homebuilding will reel from a- D* k% w. u, O
cyclical downturn, the degree of structural weakness appears
" T& @) @5 ^" W: ]; R5 [. S2 i( klimited – with the important exception of the Toronto
5 C$ [ I! r' X" ~condo market. Both in Toronto and Vancouver, historically
5 _$ G+ s7 o# D6 I# A- h& ~* hhigh levels of apartment-style units presently under
, Y( L/ s: A7 k; W z) V* Fconstruction mean that record numbers of condos will
( [4 ? p* e& Y ~4 i) p/ ]% _4 [reach completion during 2009. If absorption rates fall, as
- X! E7 u( Y* @cyclical factors would indicate, condo inventories could% [5 o1 z. G( z6 S% t
spike severely – particularly in Vancouver. However, while
/ {' r5 y8 s; S0 eresidential construction in B.C. will definitely droop, we
8 A* H3 t5 d8 @# q1 \anticipate that the West Coast will continue to benefit from& H! |9 B3 q/ f4 |) d3 P0 s
inter-provincial and international migration over the coming
6 n. S. z+ _9 |) L7 ^( Dyears, which, along with improvements in affordability,
: }1 o a, D. G! ewill alleviate some of the pressure from overbuilding.
; P# j+ l. g7 P0 b' kOVERPRICED AND OVERBUILT: CANADIAN HOUSING, m/ D; l' b& O7 d
MARKET RETURNS TO FUNDAMENTALS
A5 L0 }) v7 l: ]Grant Bishop, Economist. ~, t+ P$ H. y8 x4 M- B
416-982-8063" f% y5 X" r% A2 B5 \: H2 `8 x
Pascal Gauthier, Economist
) m, g, C9 ?: a* V a ?416-944-5730
7 E8 o1 E; G/ v* q, Z9 F3 e2 A' P- i3 d( i. e
http://www.td.com/economics/special/gb0409_housing_exec.pdf |
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