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During Canada’s “Housing Boom”, which ran roughly
# \$ l( ?6 r# G% pfrom 2002 to 2008, unsustainable price increases drove
6 F, |1 Z- R0 v9 M7 _8 n" V% u2 Yunsustainable levels of building. Our view is that house3 d+ s4 Q% S6 _# `+ T* c
prices exceeded the value of housing that was justified by
1 U; W; e. u O5 dfundamentals by approximately 9% nationwide. This
* P9 f( |' r3 k3 @' toverpricing compelled a level of residential construction9 W# Z+ c' E/ S
that exceeded its fundamental-justified level by approximately% A% L- l I- q! C; Z
12%, an excess that was exaggerated in the past
]: h4 C6 d+ z! I4 ?three years.5 z* t. c, T/ H8 S6 k& J
By “overpricing” we mean that prices detached from
& z. T7 M; ~( D- N/ A: k" Ktheir fundamentals, as witnessed by a steep erosion of
: T% y U# ^1 z1 Uaffordability. The current unwinding of house prices reflects) \$ N+ [ L# s R$ A3 C6 Z
both a cyclical downturn and a return of house prices' j$ G2 H8 `) }& _
to fundamentally justified levels.! u0 x" L8 H8 }6 f4 S ^
We consider “overbuilding” of two forms: “demanddriven”
! z0 T i, Y5 Z- d. |; P$ Twhere homebuyers buy up too many houses and
Q$ n" p- @4 V8 p x. f& z+ x( j0 sthat this demand cannot be sustained; and “supply-driven”
[- q3 Y# j. w' F) ~where builders accumulate excessive inventories. Although7 ?$ v: {8 ?; }+ A
there is evidence of both types, we contend that Canada’s
8 x- S: R0 O7 v) a“overbuilding” was mainly of the first type, where( I) f$ U) n% |1 O
homebuyers pushed homebuilding to an unsustainable pitch2 K6 g4 G6 u* \ w
that is now being rapidly reined in.: }( G% }1 R2 O6 N
While most markets won’t face U.S.-style overhangs,4 S+ G9 i+ u7 G+ Q
the construction of too many new homes over the boom
& R+ l1 W0 e- } \ G( e C( i1 x$ Ameans a deepened slump. This overbuilding will likely weigh) Z5 {8 T( D Q
on markets over the next few years. Even as Canada recovers6 s& y; A( O8 U; \& }. u
from the cyclical downturn, house price growth will+ C" {* e$ ~; ?* T
remain choppy and new residential construction will be
& o2 `7 D) r& a5 P$ `dampened, owing to this structural weakness. Construction2 k7 F: _+ ?, `" w
is now undershooting fundamentals and we expect this
; b- X' |, A* [to persist over 2009 to 2011. We anticipate that nationwide
* p+ k5 \9 R q' O* a$ h: ?residential construction will fall further to around$ D3 Y, v; Z( C2 b0 F3 S% P
125,000 starts over 2009 with a trough around 115,000 units/ B9 i/ p( b4 D' u5 y$ T- Y s* {
in the fourth quarter.9 ^% I1 S% S1 n# L
To quantify the degree of overpricing and overbuilding,3 p: x: V; ]4 j8 S
we first develop an empirical model, based on long-run0 o" f9 R7 ~. u. @6 f' w
fundamentals of house prices and housing starts in each. g1 O( D) K5 f4 O- m# M1 n! a
province. Affordability is the key concept behind home
5 `, a* u; h, dvalues since house prices should track incomes over the
% k2 T0 e& v+ @3 J3 Z# t( c% }long-run. Since homebuilders build to meet demand, we+ {- o* Q" K1 |- J2 ?8 J
regard housing prices and household formation as the drivers; J; B5 ^, q: j% J
of residential construction.
# q1 f0 X! n, d5 o4 lTo examine the degree of overbuilding, we employ a
; L! |) A5 m7 o1 h0 k$ F7 f0 o“counter-factual,” asking what level of residential construction4 h. r8 U m+ h1 P0 g
would have occurred if housing had been priced' k, ?, D( G+ a- E: j8 a+ l! _
optimally. We find that actual homebuilding exceeded this- ]8 o5 y2 @! w
fundamental-justified level by about 12%. Although new
5 R2 E+ c, P6 M% l* Wunits were being absorbed, homebuyers simply bought too! e* a$ Y" e! h+ i& t
many houses at prices that exceeded fundamentals./ m0 t% m0 M/ G4 C6 I+ W. Z7 T! Y. e
Regionally, we see the greatest strains on the Prairies,
: B" B, ~6 S7 F ywhere housing demand will further contract under waning
u6 y+ F2 O4 ppopulation inflows. Saskatoon, Calgary and Edmonton are
" b* u9 X# m. |3 e4 q a6 N: halready witnessing surges in their unsold new homes at the* @" \; e: N! S* {7 ^0 J, {1 J
very time that the resale market has swung into strong, R s6 ^9 ?/ _) n- e( b! [
buyers’ territory. Homebuilding in the Atlantic provinces: }, E+ }! {& v# q" I. U5 F
has been relatively balanced but, while not plagued by structural
& m. W, D8 `3 O6 W; ~weakness, will be singed by the downturn nonetheless.4 Z& `, `5 \7 g+ l$ O% n3 }
Québec shows signs of strain – especially given the( i) m8 E: F9 a4 w$ b
strange accumulation of unabsorbed multiples on l’Île de
: W) i/ \- U0 y! B. X- yMontréal – but recent building has been relatively balanced," k/ d0 Z4 i$ A% j2 L
given the province’s history of under-building and low ownership0 q" I- S5 w9 g1 ~/ O
rates. While Ontario homebuilding will reel from a) q( f5 R: a |8 i: a _
cyclical downturn, the degree of structural weakness appears
8 h8 ]/ J7 }9 h# E2 N U0 \limited – with the important exception of the Toronto
. U+ K; Y; }' B0 ?( e, x3 ?condo market. Both in Toronto and Vancouver, historically5 W7 a- @+ E. D4 x, l6 h0 \
high levels of apartment-style units presently under% ]3 h; X& C3 A5 t% |% |
construction mean that record numbers of condos will, k% b2 [$ Q- X: ^6 K' ?. x! C
reach completion during 2009. If absorption rates fall, as
. I" q9 F( @# J5 Q0 j' K7 q5 y. xcyclical factors would indicate, condo inventories could3 L2 }+ u2 o; I& y: R+ e
spike severely – particularly in Vancouver. However, while
7 z k2 N" K* ^# ?5 ?. F9 U% Tresidential construction in B.C. will definitely droop, we& W! ?& d. ^6 t. A1 V
anticipate that the West Coast will continue to benefit from
7 h/ E5 K$ s( R% |, uinter-provincial and international migration over the coming4 K8 H* r: m) @- Q! y
years, which, along with improvements in affordability,
9 I$ b9 m1 G6 b$ M$ dwill alleviate some of the pressure from overbuilding.: `* R5 ?8 _' c
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
' h1 N1 i; R: AMARKET RETURNS TO FUNDAMENTALS) @/ z, W+ f- H; F* X6 h9 v+ X& ` S
Grant Bishop, Economist
7 N' G$ `2 Q6 t! q416-982-8063" g3 D7 t6 J0 c; p8 j, a2 I k
Pascal Gauthier, Economist" f4 i, j- ^8 w- {6 v( [
416-944-5730
: }5 S) f" J4 E! P5 D: d5 e3 @; B9 h8 O6 G/ X! Z) {) \
http://www.td.com/economics/special/gb0409_housing_exec.pdf |
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