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During Canada’s “Housing Boom”, which ran roughly4 i1 D G6 Y& \. R# s
from 2002 to 2008, unsustainable price increases drove0 G: L) c" \9 W' D0 |! V: l( E# l
unsustainable levels of building. Our view is that house
2 V/ K( h: M2 x& a) v! }prices exceeded the value of housing that was justified by
+ J _2 O5 m: K- zfundamentals by approximately 9% nationwide. This" v. H. l4 Q5 S0 Q1 [, `. v
overpricing compelled a level of residential construction
: Y5 y. r* _7 y* l! S9 _that exceeded its fundamental-justified level by approximately
6 F& U6 n+ _ Z! {12%, an excess that was exaggerated in the past! B0 V$ Q+ I; S# K/ J, D1 M( p+ C
three years.
1 H* U' h2 G2 R) c- k' S8 ]By “overpricing” we mean that prices detached from# }, j( y& u1 H' x/ X% l6 e( B
their fundamentals, as witnessed by a steep erosion of. t$ B. h6 }. _) `. p- ~
affordability. The current unwinding of house prices reflects4 t c0 z, O9 f7 V% d2 m, T
both a cyclical downturn and a return of house prices9 |4 ?; _6 N: M" o7 M+ s+ n( S, R
to fundamentally justified levels.
4 q, ~5 b( X% ]. GWe consider “overbuilding” of two forms: “demanddriven”: F* r! ~8 m. q9 A9 ^% a+ J
where homebuyers buy up too many houses and
. M$ p, E0 F* \* k; [& T5 Ethat this demand cannot be sustained; and “supply-driven”
O% t6 A# u2 w: }* Rwhere builders accumulate excessive inventories. Although7 u: v+ O6 ]0 {* S) P# `9 H x
there is evidence of both types, we contend that Canada’s
' ?7 |" ?1 |2 t: K0 R3 y“overbuilding” was mainly of the first type, where9 {, f' q* T8 {* p) G5 G0 z
homebuyers pushed homebuilding to an unsustainable pitch/ {) |! j9 _2 |( A7 F* L6 j
that is now being rapidly reined in., p: j, L" n ]- B+ e, O
While most markets won’t face U.S.-style overhangs,5 |0 t* T/ {2 Q) F5 K
the construction of too many new homes over the boom# ?& R. K8 E8 p# H
means a deepened slump. This overbuilding will likely weigh
, o/ b: u+ h# A, aon markets over the next few years. Even as Canada recovers
' ?- l* P, G( T V! O9 D6 r! ufrom the cyclical downturn, house price growth will
1 l; w7 |* x0 r/ f- T/ C8 Tremain choppy and new residential construction will be
4 W, [% ^; Q: U/ T. Z) {8 Udampened, owing to this structural weakness. Construction# I% o; O- w9 k# W2 o
is now undershooting fundamentals and we expect this0 ~2 ^+ A( E f* A6 E$ k3 J
to persist over 2009 to 2011. We anticipate that nationwide
; B4 C& |& U( n$ S2 @! f) ?residential construction will fall further to around
9 y! ^+ h# b' o# n0 o0 h3 i125,000 starts over 2009 with a trough around 115,000 units
/ P9 W' Z% @2 {8 qin the fourth quarter.$ A5 j, v1 Y' q! B$ I% [
To quantify the degree of overpricing and overbuilding,, |4 E* b) A1 e7 a9 ~6 h& P
we first develop an empirical model, based on long-run
8 s! ]3 n3 s( O6 J( X% L6 x" ?* M8 Cfundamentals of house prices and housing starts in each
0 g* v8 v. `: b. h- F* Qprovince. Affordability is the key concept behind home
+ s( w& P8 c3 ]* M, kvalues since house prices should track incomes over the Q! O4 m! T2 h( \" _1 E, V- u& t
long-run. Since homebuilders build to meet demand, we
. {& d- Q3 d2 g! X, o: Y$ S1 f6 @6 f7 gregard housing prices and household formation as the drivers" _" r4 a0 ^ F) k1 s# {% X2 P
of residential construction. r! I: w8 c2 s! \
To examine the degree of overbuilding, we employ a
2 z: I% g; u" k2 N3 l/ v“counter-factual,” asking what level of residential construction
/ P$ l$ y" P7 R! s; @) hwould have occurred if housing had been priced
' j1 e0 D9 G5 E( i- P! _optimally. We find that actual homebuilding exceeded this
7 O0 E3 W" s( K$ D b0 ]fundamental-justified level by about 12%. Although new
/ f# J& I. U: e0 Yunits were being absorbed, homebuyers simply bought too: l! Z3 S# P0 M! |8 [) m7 e
many houses at prices that exceeded fundamentals.% S) C6 [- y3 @( u1 ?: f; O
Regionally, we see the greatest strains on the Prairies,
^& h8 n, y. kwhere housing demand will further contract under waning
: d2 J4 w7 y, W: S6 V. s1 Kpopulation inflows. Saskatoon, Calgary and Edmonton are
& `/ M) y7 O4 B2 Yalready witnessing surges in their unsold new homes at the
& @# i* d; i0 N, v% H/ Cvery time that the resale market has swung into strong* Z) E! e, D5 M) j
buyers’ territory. Homebuilding in the Atlantic provinces
7 @* b; Y& Z; N" [has been relatively balanced but, while not plagued by structural# x& e3 a: M1 n \' P% g% M
weakness, will be singed by the downturn nonetheless.& J7 z- l& [& { b
Québec shows signs of strain – especially given the& z7 @% |4 I+ x
strange accumulation of unabsorbed multiples on l’Île de/ E7 c& a: b6 n9 l+ n x
Montréal – but recent building has been relatively balanced,8 V& x; H5 j( B3 _% |
given the province’s history of under-building and low ownership
' j6 g1 ?- X/ L2 s; B0 k/ Y4 arates. While Ontario homebuilding will reel from a N0 ~, C: i) |) F+ f* G0 [
cyclical downturn, the degree of structural weakness appears
+ F8 `; U- i, S- {3 dlimited – with the important exception of the Toronto
( W$ `; M& V/ i }7 ~ g$ mcondo market. Both in Toronto and Vancouver, historically
2 W) s: |0 @) Phigh levels of apartment-style units presently under( h8 Z$ Z! K, v- p$ H6 O3 n% [
construction mean that record numbers of condos will# t7 R3 n) L& x! T7 `
reach completion during 2009. If absorption rates fall, as; z6 j Y; Y% J4 E7 R; o8 u& K& ^
cyclical factors would indicate, condo inventories could
& M, |, ?! f. I* n, X# kspike severely – particularly in Vancouver. However, while( A* B; E3 X& g+ w( N" \0 D# D* A
residential construction in B.C. will definitely droop, we
! F9 C7 l* N% q) M5 W# J! Canticipate that the West Coast will continue to benefit from
8 D- J3 @+ |$ L. w0 Z Z5 s! Tinter-provincial and international migration over the coming0 M, H% a1 Y0 @& L
years, which, along with improvements in affordability,# A( X5 v# Z4 m3 i+ z
will alleviate some of the pressure from overbuilding." X: I m# r$ Q5 w8 W- ?' c, z3 r
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
: h Q8 A, C; h% B+ uMARKET RETURNS TO FUNDAMENTALS
( k& s0 j7 j1 R1 bGrant Bishop, Economist, h) P" M2 `: ]) \& N: @' k
416-982-8063. ~ t/ ^ w9 S: o. A
Pascal Gauthier, Economist
/ M( x5 h$ o& e5 ~8 v4 L0 `8 B416-944-57302 E( g/ E# e! }2 M! A) {
}9 m$ z t/ ^3 E& u" ?3 k( n1 @4 khttp://www.td.com/economics/special/gb0409_housing_exec.pdf |
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