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During Canada’s “Housing Boom”, which ran roughly1 |4 x7 w; ^) l$ l% Q' `
from 2002 to 2008, unsustainable price increases drove
0 C7 Z. _' B" t9 Bunsustainable levels of building. Our view is that house
9 j' b- o" ~% _$ ~0 c1 L1 v/ Cprices exceeded the value of housing that was justified by
* |/ w* c* ]" o) b6 A( {fundamentals by approximately 9% nationwide. This4 `8 p9 K o$ }- M7 Q* _
overpricing compelled a level of residential construction
1 Z. P0 u! O3 W1 O5 d: Y) H" jthat exceeded its fundamental-justified level by approximately
5 r3 M) Q/ H: I) S( n12%, an excess that was exaggerated in the past
/ K. v4 G) S: U/ B2 V# Ythree years.- g: k- T# h3 L, U! ]
By “overpricing” we mean that prices detached from, m( a0 F$ s$ h# K3 J6 H
their fundamentals, as witnessed by a steep erosion of
/ Z9 ~! n3 F1 R# J% aaffordability. The current unwinding of house prices reflects- u" ~& o% {4 s
both a cyclical downturn and a return of house prices4 `8 ]) O4 X: |7 M
to fundamentally justified levels.4 P" ?/ @2 g- w w2 ^
We consider “overbuilding” of two forms: “demanddriven”
' c) F _- w; C/ g2 a/ v! Rwhere homebuyers buy up too many houses and
7 c: Q6 A: u7 s1 E9 S8 S/ zthat this demand cannot be sustained; and “supply-driven”
a7 |& c$ l l2 @/ c6 Y$ H% @where builders accumulate excessive inventories. Although- v+ D7 s. K% V) A
there is evidence of both types, we contend that Canada’s" k: M- o8 F2 b
“overbuilding” was mainly of the first type, where
' Q# U8 b5 _9 b1 B* V1 J& Fhomebuyers pushed homebuilding to an unsustainable pitch
( A& x2 R$ O" G% f6 a" wthat is now being rapidly reined in.
/ h* S0 Q4 y: x! {While most markets won’t face U.S.-style overhangs,+ d9 a; M0 n4 }4 s& N2 P" {
the construction of too many new homes over the boom! ~+ ^3 g- w5 l m. X
means a deepened slump. This overbuilding will likely weigh
3 j6 }. V" D( S) B3 n" _& con markets over the next few years. Even as Canada recovers9 r, U+ }* Z1 n1 }6 i
from the cyclical downturn, house price growth will3 ]/ k2 G+ y4 y a
remain choppy and new residential construction will be& r! `. A, ^) {& D
dampened, owing to this structural weakness. Construction
0 W- J* ^1 m! `/ Nis now undershooting fundamentals and we expect this
7 a W- @ o" m0 M) Bto persist over 2009 to 2011. We anticipate that nationwide
4 I4 Y% e8 Z0 f6 J' J' lresidential construction will fall further to around
+ O+ |6 p5 G, s$ s' |125,000 starts over 2009 with a trough around 115,000 units
' H) _: d% g: c& U8 u& R* O+ d& lin the fourth quarter.
7 C% b; l( o; r8 }: uTo quantify the degree of overpricing and overbuilding,
2 U$ l( Y F3 u8 [6 w Qwe first develop an empirical model, based on long-run
+ ]0 a* {+ n( m- K' X/ a; R/ Gfundamentals of house prices and housing starts in each
* B) y3 f# V7 J/ L9 w( R, p% jprovince. Affordability is the key concept behind home/ S/ a3 }6 z5 J% b) _( [
values since house prices should track incomes over the$ L6 s* ~9 m: C1 b( ^
long-run. Since homebuilders build to meet demand, we$ V4 d3 X/ w+ R4 E
regard housing prices and household formation as the drivers! _2 p( c0 `( @- B, e1 [$ i
of residential construction.( Q3 t: U, ?3 j' s
To examine the degree of overbuilding, we employ a
, G; A2 I9 Y) v9 i) ?: W“counter-factual,” asking what level of residential construction
' g* j- w) n4 E% }# lwould have occurred if housing had been priced& e1 j( x& n- ], U% D
optimally. We find that actual homebuilding exceeded this
p$ `' ~% q* ?fundamental-justified level by about 12%. Although new
4 Y1 M, F1 h& ]( E; _! ?units were being absorbed, homebuyers simply bought too
1 }) o" \2 T1 d7 M9 Z- s1 C) A0 Wmany houses at prices that exceeded fundamentals.2 p Y# l- b1 _
Regionally, we see the greatest strains on the Prairies,
0 k/ K5 k2 C0 W5 W4 Q( c3 h! fwhere housing demand will further contract under waning
0 W+ l, H9 K F* l( Qpopulation inflows. Saskatoon, Calgary and Edmonton are# n0 C- z' L9 g- w6 c9 N! c) w; Q
already witnessing surges in their unsold new homes at the
' v; b: n7 k+ h& ~2 mvery time that the resale market has swung into strong' C7 D/ `2 x$ H% D2 i
buyers’ territory. Homebuilding in the Atlantic provinces7 a5 G" g: J, Y4 v3 \) }+ i
has been relatively balanced but, while not plagued by structural
0 f3 j R. Q: A9 L9 z0 N$ \7 Iweakness, will be singed by the downturn nonetheless.
) j' J' { \1 I# v s9 XQuébec shows signs of strain – especially given the
: t) ~9 ^& `$ w* c9 j9 l( o% tstrange accumulation of unabsorbed multiples on l’Île de
& }& s1 M4 s5 O/ P4 z M5 {4 J' gMontréal – but recent building has been relatively balanced,
8 X$ ?) t: v! ~given the province’s history of under-building and low ownership
- f# }0 L' x/ |rates. While Ontario homebuilding will reel from a3 q6 o% k, \3 v- q
cyclical downturn, the degree of structural weakness appears1 @: g5 U, ]) _/ ~5 f9 B+ u
limited – with the important exception of the Toronto
k1 c- g: \" [' Kcondo market. Both in Toronto and Vancouver, historically" V; `+ i4 W0 B; Y( r
high levels of apartment-style units presently under
2 c; `! ^( w9 w' D- Y, cconstruction mean that record numbers of condos will
8 k& O0 |8 f0 e4 w/ y6 [reach completion during 2009. If absorption rates fall, as
9 `* S/ W" T0 @ t" dcyclical factors would indicate, condo inventories could) e. Q$ a0 W6 {; W
spike severely – particularly in Vancouver. However, while
; b7 {5 I2 n2 d H7 uresidential construction in B.C. will definitely droop, we
* {5 V4 ?6 N0 o: Danticipate that the West Coast will continue to benefit from
2 }& d8 M O8 Yinter-provincial and international migration over the coming
+ d4 p" y# v4 G/ R: Y0 Lyears, which, along with improvements in affordability,- C v3 [% q$ u- }+ x! |
will alleviate some of the pressure from overbuilding." y7 ?8 c6 G2 s& Z' z! t0 I w( M
OVERPRICED AND OVERBUILT: CANADIAN HOUSING. {! C. ~+ L: `' m Q
MARKET RETURNS TO FUNDAMENTALS
3 f$ \( N; Q. C* n3 D# ^Grant Bishop, Economist9 g# I( ?4 s3 Y
416-982-80631 w- @" K! t0 t! ]6 u3 i' W
Pascal Gauthier, Economist6 z, m, T; Q8 s; n1 f9 s
416-944-5730
4 n% X; Q1 {5 d* g6 a! Q- \
6 `) \+ k. E( {& Y* p$ Nhttp://www.td.com/economics/special/gb0409_housing_exec.pdf |
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