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During Canada’s “Housing Boom”, which ran roughly, O9 O& e! m+ @9 C3 Y
from 2002 to 2008, unsustainable price increases drove, x$ L9 a6 f' W
unsustainable levels of building. Our view is that house! |! `+ V) M- l& P$ e
prices exceeded the value of housing that was justified by7 \; [' M$ F3 d9 I
fundamentals by approximately 9% nationwide. This/ K; v4 a8 n# q
overpricing compelled a level of residential construction* k1 z/ a$ |" U, ~
that exceeded its fundamental-justified level by approximately
/ H2 r* H! [7 _$ Q. ^% `5 U; r) l12%, an excess that was exaggerated in the past
|' `# x: F% b. @+ ?% P! H6 }three years./ p5 c* u% O' l* J0 c. k
By “overpricing” we mean that prices detached from9 Z! E/ K0 G# O! p
their fundamentals, as witnessed by a steep erosion of: N5 J: P3 {" {( c3 I2 x) E. n
affordability. The current unwinding of house prices reflects# m' s1 B+ i* n8 H9 O
both a cyclical downturn and a return of house prices, r1 G- {' m6 c# w3 [1 }# c
to fundamentally justified levels.
! \: ]6 v1 T$ sWe consider “overbuilding” of two forms: “demanddriven”0 O" ~( J7 V2 ]" _$ m0 A- [0 v6 }
where homebuyers buy up too many houses and
7 l& [3 f7 s6 _! [that this demand cannot be sustained; and “supply-driven”$ P) g* J' m( @1 T& U& B
where builders accumulate excessive inventories. Although
& a1 H" c3 I" |" y5 y. Tthere is evidence of both types, we contend that Canada’s
4 ]0 L; q4 ~; F0 k0 ~5 N0 c! P“overbuilding” was mainly of the first type, where/ E% E7 M% l! ?; F# {
homebuyers pushed homebuilding to an unsustainable pitch6 V8 o( g% @! m' K* J
that is now being rapidly reined in.% B) `6 S% g$ T+ M; C
While most markets won’t face U.S.-style overhangs,: a' w5 A2 U, T
the construction of too many new homes over the boom4 ?. H5 |" n! T' d7 {4 R
means a deepened slump. This overbuilding will likely weigh/ m% B( Q/ J" w- G# t
on markets over the next few years. Even as Canada recovers
1 ~" Y) K7 k9 g- J7 E* m8 l4 xfrom the cyclical downturn, house price growth will
8 a/ P$ C6 j4 i% [/ z) n' j8 Iremain choppy and new residential construction will be- |8 Y; U2 V, o' A8 g$ b0 @7 o& d2 |( a/ v
dampened, owing to this structural weakness. Construction
9 U% r: R! E1 S1 vis now undershooting fundamentals and we expect this
$ e" f8 }2 v& W* ito persist over 2009 to 2011. We anticipate that nationwide
: }. }$ w, [( M1 D$ [' a! [/ qresidential construction will fall further to around" B }8 d' k' _7 `& E6 o
125,000 starts over 2009 with a trough around 115,000 units
8 S% B3 L- _5 P, Y' Kin the fourth quarter.+ A9 V5 Y3 [1 I: r {: }7 E
To quantify the degree of overpricing and overbuilding,0 R! R& h# f5 ^
we first develop an empirical model, based on long-run! W: C) x* R9 R; @2 ?; x$ m* |7 V" M
fundamentals of house prices and housing starts in each
1 ?' B/ U5 p; y ^2 e3 f+ Cprovince. Affordability is the key concept behind home$ M, g |1 N" ~
values since house prices should track incomes over the
" _, d. n! I+ Slong-run. Since homebuilders build to meet demand, we
8 }: u, P2 i+ t5 q( Nregard housing prices and household formation as the drivers
& h1 F+ c" D/ ], F5 J5 s1 Oof residential construction.0 \( D0 p1 [$ j$ K8 E. s' Q
To examine the degree of overbuilding, we employ a
# U5 c. y* Z* N; m“counter-factual,” asking what level of residential construction
3 s2 ]! x% `: Rwould have occurred if housing had been priced
$ ?6 y& I% G# }0 `optimally. We find that actual homebuilding exceeded this
6 R, |9 ^. B# t3 gfundamental-justified level by about 12%. Although new+ C& Y9 G- z2 s& A+ V) n, `
units were being absorbed, homebuyers simply bought too
- ^2 o. ^3 U, p( y$ Jmany houses at prices that exceeded fundamentals.2 ~3 a% A) ^) d6 o
Regionally, we see the greatest strains on the Prairies,4 ^; G, z6 m! Z: K
where housing demand will further contract under waning
+ _9 A$ G/ v/ Y6 _. u8 Upopulation inflows. Saskatoon, Calgary and Edmonton are
2 S) t$ y2 a8 V4 Qalready witnessing surges in their unsold new homes at the( N- ?% Q; g: T( f5 `: X
very time that the resale market has swung into strong% w6 B Q* w+ s3 O; S' A
buyers’ territory. Homebuilding in the Atlantic provinces
. o& j: H* \* e& Whas been relatively balanced but, while not plagued by structural* {7 W+ |8 P# R9 {3 T
weakness, will be singed by the downturn nonetheless.
& s- `7 K% Z7 l0 P1 X( Q( qQuébec shows signs of strain – especially given the
) P4 P5 Y" S- J4 d- W: Y" Q" ~strange accumulation of unabsorbed multiples on l’Île de6 P& y: M5 b1 ?
Montréal – but recent building has been relatively balanced,; p: `$ v5 a& @( Z4 {1 [
given the province’s history of under-building and low ownership
7 [5 u' V( u. i8 B: lrates. While Ontario homebuilding will reel from a2 s0 M9 N) l; x; B
cyclical downturn, the degree of structural weakness appears# t7 a3 W8 N m/ e" v
limited – with the important exception of the Toronto8 ]( M, L! S' r7 e
condo market. Both in Toronto and Vancouver, historically/ o! A, g+ k/ q: m
high levels of apartment-style units presently under
5 k* y! ]- \6 V4 cconstruction mean that record numbers of condos will& i1 ]( A; {' I8 d4 ~7 c
reach completion during 2009. If absorption rates fall, as
6 \/ ~4 Y* d1 n" r6 Z. tcyclical factors would indicate, condo inventories could v( H5 x. o# C' Y5 @$ s3 U( M
spike severely – particularly in Vancouver. However, while
! [$ G" V2 z' i5 presidential construction in B.C. will definitely droop, we, [: Y' ]; |3 K- Z& y
anticipate that the West Coast will continue to benefit from8 [* z9 C+ G8 E
inter-provincial and international migration over the coming
3 m, J2 ^# F- l$ V! I1 m. `years, which, along with improvements in affordability,
/ G1 a: d: Q: [ W7 r3 Kwill alleviate some of the pressure from overbuilding.
9 N R7 I5 p' i5 g9 C" v, QOVERPRICED AND OVERBUILT: CANADIAN HOUSING8 }6 h( M; O s% ]/ ?- `
MARKET RETURNS TO FUNDAMENTALS' c6 ^2 _) _2 s
Grant Bishop, Economist
: J% l+ f# ]* d. K416-982-8063
J5 g$ ~! k/ u" ?. V; l; APascal Gauthier, Economist
' n2 i" ^ [+ O416-944-57309 |" w6 z d) d8 Z+ ~/ {- E C. m8 r6 f
5 C' y; d, z% X S( s$ bhttp://www.td.com/economics/special/gb0409_housing_exec.pdf |
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