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During Canada’s “Housing Boom”, which ran roughly
2 z: o7 e7 ~% M) rfrom 2002 to 2008, unsustainable price increases drove! `2 o. u, [& t0 O
unsustainable levels of building. Our view is that house
# W, j+ x4 r" F1 `( r$ Yprices exceeded the value of housing that was justified by$ i$ @ L3 _0 N, k0 u
fundamentals by approximately 9% nationwide. This
y- I: W2 T% C" e Z' f+ F3 Coverpricing compelled a level of residential construction! Z: L1 @2 L0 Y4 J b
that exceeded its fundamental-justified level by approximately" } p# h- s |* i# E
12%, an excess that was exaggerated in the past6 m& Y( u4 N: d. \5 ^
three years.% h6 n e ]6 `' u
By “overpricing” we mean that prices detached from
5 ]3 Q e3 c# N$ Ltheir fundamentals, as witnessed by a steep erosion of
; m' I2 s; v c" E- ]2 \affordability. The current unwinding of house prices reflects
* @% N$ V. B9 P; }' I, aboth a cyclical downturn and a return of house prices% S% o$ t1 Y- C
to fundamentally justified levels.
4 ]' {8 o9 c( zWe consider “overbuilding” of two forms: “demanddriven”0 b9 s8 P, i5 S$ K4 d! [% @% K
where homebuyers buy up too many houses and7 }" z$ Q3 Q2 Z: Y% `
that this demand cannot be sustained; and “supply-driven”, k2 e8 z# J" ^* Z/ W$ U/ |- k
where builders accumulate excessive inventories. Although3 Q$ _ h9 I9 S( |6 `! D
there is evidence of both types, we contend that Canada’s. g) H: n# c# E+ B9 Z4 _. x
“overbuilding” was mainly of the first type, where
) m3 w) j* Y: x/ Hhomebuyers pushed homebuilding to an unsustainable pitch
$ P* _& A/ R! y9 [/ P! h8 c% ythat is now being rapidly reined in.
2 } Z0 M* {5 j9 t n9 `1 wWhile most markets won’t face U.S.-style overhangs,% a6 j9 I" P$ n. _ J
the construction of too many new homes over the boom* t: r/ y- D+ b2 y9 z
means a deepened slump. This overbuilding will likely weigh
6 o9 W5 e9 J/ u5 Q2 s6 ]5 Ion markets over the next few years. Even as Canada recovers
3 _6 i; j [6 w2 \( F1 }from the cyclical downturn, house price growth will) D3 F7 K. H) V+ c# N' X# w
remain choppy and new residential construction will be4 [7 K1 y7 x9 j/ B" S# f2 e
dampened, owing to this structural weakness. Construction
* F) D- ^( s1 m- E6 X0 L* _3 `is now undershooting fundamentals and we expect this- n5 [* q' P- u8 m( t5 s6 T
to persist over 2009 to 2011. We anticipate that nationwide
2 D7 } C! D4 Z, x' g( o' wresidential construction will fall further to around0 Q; f% W' e B0 q$ f
125,000 starts over 2009 with a trough around 115,000 units
. X1 V. X. o7 D$ j) H. @in the fourth quarter.+ J/ s6 a* f$ U0 Y8 l+ l5 ?) W
To quantify the degree of overpricing and overbuilding,
' @) {0 g7 W o( Cwe first develop an empirical model, based on long-run0 b. `% h. b8 x8 _+ B: ~
fundamentals of house prices and housing starts in each
2 ~8 p, L$ y. B% M) Fprovince. Affordability is the key concept behind home1 H4 {0 D2 D$ E
values since house prices should track incomes over the
9 w+ C7 A: z" Klong-run. Since homebuilders build to meet demand, we
/ P( g! Q- A" kregard housing prices and household formation as the drivers
' y% p9 f* z, `5 i' L$ oof residential construction.
/ b' J5 a" k+ u. k+ tTo examine the degree of overbuilding, we employ a
6 e0 k6 d% ]2 Y! B$ J1 w9 C9 J“counter-factual,” asking what level of residential construction, K6 X3 q: C' E: m O! M! M7 [/ n" A
would have occurred if housing had been priced; u" Q" Q2 g9 c, n5 E0 m
optimally. We find that actual homebuilding exceeded this
6 N, m5 a# R% L( ffundamental-justified level by about 12%. Although new2 |! D4 G, A9 q5 A) K$ h, i, W
units were being absorbed, homebuyers simply bought too
. }8 p2 Q* Q+ K7 R8 U1 m/ c$ D: hmany houses at prices that exceeded fundamentals.
) D! g4 L, M1 j: K4 dRegionally, we see the greatest strains on the Prairies,4 ^0 _6 D* s" L
where housing demand will further contract under waning
# h1 h6 N0 L+ [population inflows. Saskatoon, Calgary and Edmonton are" r0 K ~, p/ D5 k, x% s% x3 C
already witnessing surges in their unsold new homes at the
7 B( z2 ~ n' A9 v/ V/ _9 Qvery time that the resale market has swung into strong& m! L8 m' s3 m' h
buyers’ territory. Homebuilding in the Atlantic provinces% H: T/ ? \3 ?$ a6 F B* V: l4 c) x
has been relatively balanced but, while not plagued by structural8 J4 J0 k- Z5 u3 r, z; z
weakness, will be singed by the downturn nonetheless.
, P5 m# j& b5 S' O) ^6 \1 gQuébec shows signs of strain – especially given the
" h* r' i% \3 t% a& c* ^/ k" jstrange accumulation of unabsorbed multiples on l’Île de
w: n; W5 G _/ ~Montréal – but recent building has been relatively balanced,# V W8 u( h h, I
given the province’s history of under-building and low ownership% X, i- |( \3 O$ Q' [
rates. While Ontario homebuilding will reel from a0 ]( a& E i }/ ?; I! D$ b
cyclical downturn, the degree of structural weakness appears
' Q/ a& K5 o- [. m, Zlimited – with the important exception of the Toronto
6 V: h! X8 F3 L! F' i* s5 P4 vcondo market. Both in Toronto and Vancouver, historically
( A+ }& X* `2 C/ s% N4 Ihigh levels of apartment-style units presently under
+ T0 ~3 L# V# \0 _3 w( Kconstruction mean that record numbers of condos will
- P2 U# E; C: L y8 @reach completion during 2009. If absorption rates fall, as
, L3 h. T' w( ]5 Y4 r, }cyclical factors would indicate, condo inventories could3 X, `" f4 ~1 n7 ]; [! ]
spike severely – particularly in Vancouver. However, while
4 |2 [% P9 M2 N- Rresidential construction in B.C. will definitely droop, we
( @: j/ Y+ N1 j/ ? V- Oanticipate that the West Coast will continue to benefit from; R2 g* X0 k7 ?5 `' C9 S4 a/ {
inter-provincial and international migration over the coming
|1 S- h# f7 I/ Q! {; U8 d, Pyears, which, along with improvements in affordability,
( F8 p% F3 v3 ?5 Swill alleviate some of the pressure from overbuilding.
4 P2 Q) s# e Z& m5 Y- u2 n. |& p. BOVERPRICED AND OVERBUILT: CANADIAN HOUSING
s+ g+ e* F4 P/ {# W( fMARKET RETURNS TO FUNDAMENTALS2 L2 c0 R4 J! B/ q( {* g; l
Grant Bishop, Economist
( _& c: {% g u1 ?& B$ K* z7 C, l4 }416-982-8063
1 L+ b! O( t( u! C* ^/ hPascal Gauthier, Economist0 B4 h7 e1 h! m6 t; F
416-944-5730
/ R( Y- i( ^7 _
! c; @4 V* a3 O9 C: d/ C$ @) Zhttp://www.td.com/economics/special/gb0409_housing_exec.pdf |
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