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During Canada’s “Housing Boom”, which ran roughly+ | m9 x) s0 j4 z7 D% o" f' z; t6 S
from 2002 to 2008, unsustainable price increases drove
' Y7 m, H; N- K l# n* K: gunsustainable levels of building. Our view is that house
$ H& {5 b9 b$ U) mprices exceeded the value of housing that was justified by8 J# G7 U9 o- G
fundamentals by approximately 9% nationwide. This
2 Q' G! E8 b1 {) zoverpricing compelled a level of residential construction
1 t0 Q1 Y9 n2 B) r k/ n9 ~* @that exceeded its fundamental-justified level by approximately6 S! s& X# c: _. z7 M
12%, an excess that was exaggerated in the past2 ^/ A1 \9 y8 ?2 y! ]/ \
three years.5 z5 r- W4 Q! f" g, d
By “overpricing” we mean that prices detached from8 }+ C3 o' x: _/ ^5 ]
their fundamentals, as witnessed by a steep erosion of8 R" x. V& j! c0 L( q
affordability. The current unwinding of house prices reflects* G$ R7 v# w0 L# h9 f
both a cyclical downturn and a return of house prices
; c7 P* B0 {: {( Y+ t% ^0 i7 Pto fundamentally justified levels.& I; y' f$ _9 j
We consider “overbuilding” of two forms: “demanddriven”2 T$ z# a/ E% f6 I2 i u
where homebuyers buy up too many houses and: q9 z a; _% b' b/ s$ T/ U2 d
that this demand cannot be sustained; and “supply-driven”
' w% L" ]$ i: A8 [where builders accumulate excessive inventories. Although
+ W* h, W( k) }! Bthere is evidence of both types, we contend that Canada’s
1 K) @* Z- g! d$ j: K8 y( R6 Q“overbuilding” was mainly of the first type, where
/ X( Y) w$ D: v+ _7 @8 u8 @homebuyers pushed homebuilding to an unsustainable pitch5 y' M1 L2 Y5 s/ h8 J
that is now being rapidly reined in.9 z; d4 l. l# T1 I1 i) E4 {
While most markets won’t face U.S.-style overhangs,
4 R8 z. C2 |( |/ P# Q# U: y' D% Ithe construction of too many new homes over the boom/ c# T% Z( K! c
means a deepened slump. This overbuilding will likely weigh7 g9 U, Q0 ^2 O2 d! x
on markets over the next few years. Even as Canada recovers3 M5 Z0 L8 ]5 f# D7 D5 j
from the cyclical downturn, house price growth will
, l9 n4 i) }- N) o5 f- d. Sremain choppy and new residential construction will be/ R! T- J& Z8 J5 A
dampened, owing to this structural weakness. Construction
$ T$ u4 T6 T/ i2 |9 d |is now undershooting fundamentals and we expect this
& ~: Q% z- c6 @ h7 ^& ]( Hto persist over 2009 to 2011. We anticipate that nationwide
( M% f; P: V$ o5 ?6 w5 z3 Y0 mresidential construction will fall further to around% y4 o# v9 Y, x3 O) _: ^- C
125,000 starts over 2009 with a trough around 115,000 units
5 q! C, C6 k& \+ \7 A% t" Tin the fourth quarter.
9 N3 c& p/ b1 v3 U0 r/ @* V+ f; ?To quantify the degree of overpricing and overbuilding,
d5 Y9 t4 R- n, c( f8 rwe first develop an empirical model, based on long-run
, r6 u, W0 b8 o( R+ ufundamentals of house prices and housing starts in each \; d5 ] Y [$ V& S" t
province. Affordability is the key concept behind home8 q9 |* E/ i) i7 o3 _/ q8 P3 j" Z
values since house prices should track incomes over the8 e6 V* Q. e7 _, K- P( n$ s5 k
long-run. Since homebuilders build to meet demand, we
& n/ B, u. Q4 s. E) H# I, g' }regard housing prices and household formation as the drivers* t B# {; h% w
of residential construction.
5 ?3 L* J7 m c- C, k nTo examine the degree of overbuilding, we employ a
" L {7 Q1 f& p4 l4 w8 m' |8 F“counter-factual,” asking what level of residential construction
( }6 j; t* |9 f M/ Hwould have occurred if housing had been priced
* Y# Y. h* C. A4 g! P( h2 N) hoptimally. We find that actual homebuilding exceeded this
, g( q) ?* y- d6 q! h/ ifundamental-justified level by about 12%. Although new
/ o6 m8 L [" v3 |! U/ [/ {5 Zunits were being absorbed, homebuyers simply bought too7 E7 A3 G4 I7 P, s
many houses at prices that exceeded fundamentals.
+ m& ]) F# J# ~- z6 G/ zRegionally, we see the greatest strains on the Prairies,
: J0 l) w; ]+ x' Mwhere housing demand will further contract under waning" h w5 x0 ~% Z6 N$ p9 q! H
population inflows. Saskatoon, Calgary and Edmonton are) t% S) z* c+ _ l9 ?
already witnessing surges in their unsold new homes at the7 G' ~. x$ f5 L
very time that the resale market has swung into strong' v* N: E1 P& B5 A4 G3 W
buyers’ territory. Homebuilding in the Atlantic provinces
3 @0 n/ |! S, w# e% o" S v% `has been relatively balanced but, while not plagued by structural
/ C& L# G- ]/ @9 O `: D yweakness, will be singed by the downturn nonetheless.
, [1 i4 f* k3 J ^* c. x. `+ MQuébec shows signs of strain – especially given the
" R; l, T% H. [ istrange accumulation of unabsorbed multiples on l’Île de, b( r# H- _" t" s) W: g
Montréal – but recent building has been relatively balanced,
( N, t4 ?( x. X6 hgiven the province’s history of under-building and low ownership
2 B( }4 x; c" z# c, t- E0 Erates. While Ontario homebuilding will reel from a( w) r' p9 s# b1 _* p( s W
cyclical downturn, the degree of structural weakness appears
# H: T4 a5 g% ~ J' vlimited – with the important exception of the Toronto$ D/ s5 K- @5 o8 I$ H% ^1 ^
condo market. Both in Toronto and Vancouver, historically
3 C) a! S- U' s$ mhigh levels of apartment-style units presently under- u# f( K2 ?4 x K
construction mean that record numbers of condos will# N1 k4 t. l" r+ `
reach completion during 2009. If absorption rates fall, as
- ]) Y6 O- O1 {) r5 [3 X% t# ?9 Ecyclical factors would indicate, condo inventories could' l# A- n3 {/ O
spike severely – particularly in Vancouver. However, while
_( D7 v9 I$ xresidential construction in B.C. will definitely droop, we
6 B+ h0 h7 D. X, o+ Tanticipate that the West Coast will continue to benefit from' X5 g6 Q- o$ ~4 g- d
inter-provincial and international migration over the coming( X4 u W, Y* Z% H
years, which, along with improvements in affordability,4 y( l, k5 L4 M" ^
will alleviate some of the pressure from overbuilding.4 [) b6 I2 x/ c! y
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
7 u) w1 @7 e/ D1 ^& ]) QMARKET RETURNS TO FUNDAMENTALS. U9 m6 z. P8 J8 t$ I
Grant Bishop, Economist* q$ B$ _% x, C+ x' }, B
416-982-8063& n' c8 ~! [- I! u! v$ Z- y
Pascal Gauthier, Economist
( i# a6 \7 P7 B- D416-944-5730
# P9 L$ @( O+ C, S0 I. R8 ]
3 J& o1 I4 P) ] ^1 [5 K8 ~http://www.td.com/economics/special/gb0409_housing_exec.pdf |
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