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During Canada’s “Housing Boom”, which ran roughly+ @0 j% R' y7 _7 V, B# j
from 2002 to 2008, unsustainable price increases drove
6 T4 U9 _: f' V) U G4 eunsustainable levels of building. Our view is that house
9 b+ S3 f' y+ I. t, T) @prices exceeded the value of housing that was justified by
" [/ w/ i) X7 Zfundamentals by approximately 9% nationwide. This& j& A/ W) J, [
overpricing compelled a level of residential construction% t/ z% s- a& R' t. {; [1 o- {
that exceeded its fundamental-justified level by approximately- @: g* ~, q. U H9 m* ?1 S" O, [
12%, an excess that was exaggerated in the past
7 T( j: i0 E3 n5 ^$ a: D: dthree years.4 X( ?( t$ X3 a6 m
By “overpricing” we mean that prices detached from: }# O" Q! Q( o) Y; T
their fundamentals, as witnessed by a steep erosion of0 }! C: g+ f+ N$ ~7 m+ o
affordability. The current unwinding of house prices reflects' w" u# |% E$ d k5 a
both a cyclical downturn and a return of house prices6 h- b/ ]8 E' T l, e5 a) g( V/ \. ^
to fundamentally justified levels.8 v; |- |' U) H# H$ r+ O8 V" ~
We consider “overbuilding” of two forms: “demanddriven”
: p( |1 R. p& O5 \where homebuyers buy up too many houses and
: l% f4 U+ a. e( mthat this demand cannot be sustained; and “supply-driven”
* w7 G! z; y* T5 Ewhere builders accumulate excessive inventories. Although
], x( j$ ?! F# f o+ uthere is evidence of both types, we contend that Canada’s
! z4 u0 Z9 D: L, t; ?2 T- ~0 j“overbuilding” was mainly of the first type, where+ O0 m3 g1 ]# {$ { c& ?9 m) D% n' ?
homebuyers pushed homebuilding to an unsustainable pitch
( x+ P5 U/ f* B* Xthat is now being rapidly reined in.
% j1 V- z% W- X4 \While most markets won’t face U.S.-style overhangs,
! ?# V8 a7 h6 H o- j& i5 pthe construction of too many new homes over the boom8 F4 o2 k3 G9 E1 p- w W
means a deepened slump. This overbuilding will likely weigh
, Z6 b& v2 i1 l; }0 Uon markets over the next few years. Even as Canada recovers% i( b+ _( ^; Q% ^3 H
from the cyclical downturn, house price growth will
8 B/ B3 Q e' f; Iremain choppy and new residential construction will be
: O. h: v% ^- q) Q6 ?7 Pdampened, owing to this structural weakness. Construction
/ t7 @- {% l' b# Z9 lis now undershooting fundamentals and we expect this
. t9 M- g: E* `& a" o U/ Xto persist over 2009 to 2011. We anticipate that nationwide0 T, u% t3 W: [0 r6 K! T! n
residential construction will fall further to around2 j* q" m& T2 ]6 P3 V5 B0 q
125,000 starts over 2009 with a trough around 115,000 units% J4 t4 W9 f# v* R6 b4 c
in the fourth quarter.2 F4 x6 N) k, u) D$ P
To quantify the degree of overpricing and overbuilding,* X6 S( o" S! F( \# g
we first develop an empirical model, based on long-run4 R( a0 I b8 ?/ N, c q P8 g# D
fundamentals of house prices and housing starts in each9 [" \) Q1 k; M7 Z# S
province. Affordability is the key concept behind home
! V1 U) m2 M0 o1 O) uvalues since house prices should track incomes over the- s" w* ?! W, C/ l) o# c! F
long-run. Since homebuilders build to meet demand, we% l( q' X' {, p0 r( ]# b
regard housing prices and household formation as the drivers
# ]" h. Z$ M( ^7 x0 Lof residential construction.
' t8 X5 g$ a* ~$ T wTo examine the degree of overbuilding, we employ a0 x( G! m1 B) w" ]
“counter-factual,” asking what level of residential construction
7 O9 J) T$ H; Y0 Owould have occurred if housing had been priced
2 M6 f: D& A, `4 A$ c- qoptimally. We find that actual homebuilding exceeded this7 h0 f+ l) ^+ Q* W: J
fundamental-justified level by about 12%. Although new( ]* J r, R8 I
units were being absorbed, homebuyers simply bought too
% [- l3 k* g0 _many houses at prices that exceeded fundamentals.
: } S; @% ]; I2 F9 gRegionally, we see the greatest strains on the Prairies,$ B% ^8 z; Z: O1 P4 M1 S
where housing demand will further contract under waning
# M9 l3 {. {7 r lpopulation inflows. Saskatoon, Calgary and Edmonton are% L8 v; L0 |+ ?& D' K" M
already witnessing surges in their unsold new homes at the6 Q# |7 Q) h4 o$ Z- k7 b6 H4 w2 y: o
very time that the resale market has swung into strong
' J+ [' d! X# w3 ]buyers’ territory. Homebuilding in the Atlantic provinces
( \ F! V% l% W. U$ b5 l7 [; F( ^8 Whas been relatively balanced but, while not plagued by structural
% ^/ r; P/ n# z$ Kweakness, will be singed by the downturn nonetheless., y" L9 ?& O% |: N' M
Québec shows signs of strain – especially given the/ N+ R. Z3 _# y
strange accumulation of unabsorbed multiples on l’Île de
' b! w6 X/ q7 D; MMontréal – but recent building has been relatively balanced,
+ c+ W7 d2 O7 ^# W/ Kgiven the province’s history of under-building and low ownership
& ]2 K4 B" Y$ m5 a* Prates. While Ontario homebuilding will reel from a" c3 \: L0 G* _! z! K
cyclical downturn, the degree of structural weakness appears
0 }( |" j, Q, ?; H+ Mlimited – with the important exception of the Toronto
5 S# d7 M: l5 Z+ } W) f0 e, icondo market. Both in Toronto and Vancouver, historically9 R* Q+ t9 S, r9 p9 j! G9 R4 p2 j- F
high levels of apartment-style units presently under
. `8 v3 J: n/ o5 T! t. zconstruction mean that record numbers of condos will
# G( {; R, f/ p' w) W4 ] H+ ]) J6 rreach completion during 2009. If absorption rates fall, as) u1 B% c% D8 |! b
cyclical factors would indicate, condo inventories could
7 J0 v# b5 M- h7 ^spike severely – particularly in Vancouver. However, while! s! g- G+ x- b- b1 {
residential construction in B.C. will definitely droop, we! I( h8 q& {+ R( V
anticipate that the West Coast will continue to benefit from, V2 a; w; k2 j4 }- ]
inter-provincial and international migration over the coming
7 V5 _* u+ D4 {7 u% J' F0 cyears, which, along with improvements in affordability,2 s; b; m4 c" a: g: }
will alleviate some of the pressure from overbuilding.* F( H2 B) `- p( [
OVERPRICED AND OVERBUILT: CANADIAN HOUSING1 C# z- S* c1 Y( Z5 x% I2 o A9 C
MARKET RETURNS TO FUNDAMENTALS6 R& d( S6 @* Z; y2 y* O
Grant Bishop, Economist2 B$ h. k0 o7 R6 b8 _
416-982-8063
) W4 X1 R" M- n' y# K% WPascal Gauthier, Economist
" V+ r* C) z# B/ i& f" L416-944-5730
4 E3 R9 c; y, I5 n8 _6 ~. u# [" {; b k1 _# p' Y$ U+ V
http://www.td.com/economics/special/gb0409_housing_exec.pdf |
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