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During Canada’s “Housing Boom”, which ran roughly
H5 Y" f3 E N; p4 h# J$ Zfrom 2002 to 2008, unsustainable price increases drove/ h$ Z6 J# ]1 j: C' ?! Q& ]
unsustainable levels of building. Our view is that house
8 \$ t r+ G9 o0 |6 D0 N, Gprices exceeded the value of housing that was justified by
) Z7 @% B2 l; V: k' Mfundamentals by approximately 9% nationwide. This0 M- ?% Z* P9 e& h/ Q# r5 ?
overpricing compelled a level of residential construction4 _( t% z' @, _$ B6 ]8 G+ F
that exceeded its fundamental-justified level by approximately
2 e8 B/ {# c+ p I12%, an excess that was exaggerated in the past
. Q+ I x+ a# H, `# r$ Jthree years.
4 [2 F0 K$ d; Z/ KBy “overpricing” we mean that prices detached from& ]: b% t' x# V- [" F3 D" |
their fundamentals, as witnessed by a steep erosion of
& m% b0 f" a( ^4 Waffordability. The current unwinding of house prices reflects1 h8 q' @( L8 m! _$ e5 v2 A
both a cyclical downturn and a return of house prices
# g; s/ B) U$ v( {1 J! D7 ~* fto fundamentally justified levels.
3 z8 C* M9 L0 U {& u" b+ X& s5 nWe consider “overbuilding” of two forms: “demanddriven”+ r) _: s* ~5 h3 i7 h1 Y3 T+ t6 y& b$ A
where homebuyers buy up too many houses and5 f% f; t% ~5 Q1 F; c
that this demand cannot be sustained; and “supply-driven”
0 u/ q U% H% o- M4 ywhere builders accumulate excessive inventories. Although
) w& o7 S- Y l/ f/ `there is evidence of both types, we contend that Canada’s5 S3 T9 }" W% ^. j# ]
“overbuilding” was mainly of the first type, where6 h P0 k' q: _
homebuyers pushed homebuilding to an unsustainable pitch
+ `: ^! v+ f' r/ m* kthat is now being rapidly reined in.
5 V7 n, B9 S, F. D6 v# eWhile most markets won’t face U.S.-style overhangs,+ M3 F; j# p2 T/ d
the construction of too many new homes over the boom
$ E6 z' b9 ~( J2 y: e3 Ameans a deepened slump. This overbuilding will likely weigh5 |- ?3 S- w ~; j8 F7 H( Z# r
on markets over the next few years. Even as Canada recovers& f3 w# M7 M1 q$ `
from the cyclical downturn, house price growth will
3 {- M2 \. M' K" \remain choppy and new residential construction will be# T3 B- x( d$ U, x. L' R
dampened, owing to this structural weakness. Construction- {; k9 {3 N* B% c
is now undershooting fundamentals and we expect this
% ~2 F% I3 ^/ `4 Xto persist over 2009 to 2011. We anticipate that nationwide
6 Q% k" M) e w' p" nresidential construction will fall further to around6 g0 ?3 e y0 f. F6 j- D5 f" t
125,000 starts over 2009 with a trough around 115,000 units
4 ~' \: T7 e& K! F+ B& Xin the fourth quarter.. U0 ~4 K7 G9 X; T
To quantify the degree of overpricing and overbuilding,% \% B4 Q/ N, y* q# e! {& a+ a
we first develop an empirical model, based on long-run
: B6 c# g. u5 o, rfundamentals of house prices and housing starts in each
/ G6 Z( `8 v6 I; X3 {! Lprovince. Affordability is the key concept behind home
3 z9 C0 t$ `6 A5 l$ k- {" Yvalues since house prices should track incomes over the
/ ]: y8 q6 y+ K" S1 V% p' @long-run. Since homebuilders build to meet demand, we c- }! F' Y, ^0 G+ [) e. R
regard housing prices and household formation as the drivers: W W" V3 u2 b! ]- ?8 d7 g& G& ]7 ~
of residential construction.( i7 d* H0 |; x' x# V! }
To examine the degree of overbuilding, we employ a
. C S& s& b7 T3 G“counter-factual,” asking what level of residential construction
" I1 [8 J/ f: Vwould have occurred if housing had been priced# l( ~/ g# `9 f- m- [
optimally. We find that actual homebuilding exceeded this5 w1 A0 R* x: Q. M8 P* |
fundamental-justified level by about 12%. Although new4 l" p% {9 w3 U* c: F+ q7 N& T
units were being absorbed, homebuyers simply bought too* x% \+ Q" D( m+ ~" `7 e9 F% G
many houses at prices that exceeded fundamentals.
3 e5 \$ \ N! c0 q4 iRegionally, we see the greatest strains on the Prairies,9 v/ \! H. Z: y6 e
where housing demand will further contract under waning( |0 s7 i& A, E( B% r
population inflows. Saskatoon, Calgary and Edmonton are
1 t" u9 ^( @, Z, j" A' Nalready witnessing surges in their unsold new homes at the
! n! [% x8 u @. q bvery time that the resale market has swung into strong
2 e/ k) S7 _6 Z, s x# _' Z- obuyers’ territory. Homebuilding in the Atlantic provinces
' }. ]' | \( S1 e) W: S% r- Bhas been relatively balanced but, while not plagued by structural
, \# d+ f3 O: O' d+ \* D" R. wweakness, will be singed by the downturn nonetheless.
- F+ N9 U+ h5 K8 m4 a* N! uQuébec shows signs of strain – especially given the1 }+ T- @8 G" V+ Z
strange accumulation of unabsorbed multiples on l’Île de; j* C3 Z, i6 u/ X, A [ [
Montréal – but recent building has been relatively balanced,5 n, j5 i I8 v9 @
given the province’s history of under-building and low ownership
# y6 n7 z! w" K0 L& y8 w% ^9 Jrates. While Ontario homebuilding will reel from a
7 Q- k6 X- i% r# N$ E5 x0 wcyclical downturn, the degree of structural weakness appears
$ U6 S9 x% Q. L% Llimited – with the important exception of the Toronto2 `9 S# t& m$ Z2 \ l9 f8 Y1 u
condo market. Both in Toronto and Vancouver, historically
4 s" z& H# ]6 q/ d* lhigh levels of apartment-style units presently under/ m3 l8 ~. m. \
construction mean that record numbers of condos will
g3 u2 v( w7 h& v# Freach completion during 2009. If absorption rates fall, as; M% @& u5 D# `
cyclical factors would indicate, condo inventories could' C6 {- G( C5 _' U* T* ~
spike severely – particularly in Vancouver. However, while
9 f1 b0 I8 O' Bresidential construction in B.C. will definitely droop, we
) A% u( q1 y* Uanticipate that the West Coast will continue to benefit from
" p( ~9 h4 ?% L2 linter-provincial and international migration over the coming
g9 [) b# R9 F9 y/ ryears, which, along with improvements in affordability,
2 c' U; \3 E* V z$ wwill alleviate some of the pressure from overbuilding.
, \9 w. i ^+ _- _0 X3 h. X' YOVERPRICED AND OVERBUILT: CANADIAN HOUSING
& @; O& s/ b+ h6 M2 m: SMARKET RETURNS TO FUNDAMENTALS" f3 c1 L5 U; E9 u0 c
Grant Bishop, Economist
2 D) w( l" A, [6 i' `/ o* ~: c416-982-8063
/ N. r, j' {% W- y" HPascal Gauthier, Economist D% H: w5 g4 R$ w0 D+ ?4 A
416-944-5730" S# c) T/ [, j( M" X
0 T. B" ]+ f; \" D9 ]$ Mhttp://www.td.com/economics/special/gb0409_housing_exec.pdf |
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