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During Canada’s “Housing Boom”, which ran roughly% }- @% F. V/ |& V8 n! I1 I$ r; s
from 2002 to 2008, unsustainable price increases drove% C* R; V0 U! S+ F+ n2 o8 W+ D
unsustainable levels of building. Our view is that house0 T1 P$ G! _" z' Y9 ?
prices exceeded the value of housing that was justified by, J1 J% W6 k+ z0 D
fundamentals by approximately 9% nationwide. This
- w" |3 j6 y2 K+ B9 yoverpricing compelled a level of residential construction4 w% X% r9 d; G8 V0 j7 m4 Y# d: L
that exceeded its fundamental-justified level by approximately Z! J, H3 _4 A6 S
12%, an excess that was exaggerated in the past9 g# W+ J: s9 B5 L. O8 ?
three years.& b6 V" I. {( K: p
By “overpricing” we mean that prices detached from
; r. h4 E# r1 o% o6 }+ m8 vtheir fundamentals, as witnessed by a steep erosion of
) i8 u1 |6 Z/ J4 s# k5 c1 S4 paffordability. The current unwinding of house prices reflects6 n$ k1 M- H' ~4 z4 Q( k
both a cyclical downturn and a return of house prices) M9 B& @6 ^$ I+ D$ [. k
to fundamentally justified levels.
& T$ }7 P* l& @. [ Q( d/ n0 XWe consider “overbuilding” of two forms: “demanddriven”
C2 g0 Y: ~& Z! ^where homebuyers buy up too many houses and% e5 i; T3 z5 I% P' r
that this demand cannot be sustained; and “supply-driven”
a# A3 R( T" U' @# uwhere builders accumulate excessive inventories. Although/ G3 F h. s E3 z8 c3 [& y
there is evidence of both types, we contend that Canada’s
8 V8 }4 Q2 X! r) D“overbuilding” was mainly of the first type, where
5 T9 f: f( Z5 n7 H" F+ Ihomebuyers pushed homebuilding to an unsustainable pitch4 G7 o2 v( y5 T7 `9 j
that is now being rapidly reined in.
8 ?1 T- g% t6 e! q+ GWhile most markets won’t face U.S.-style overhangs,0 ?+ R# _% J# V9 }/ G! `" H
the construction of too many new homes over the boom/ D+ F% \% I8 w! m0 W
means a deepened slump. This overbuilding will likely weigh
- G, q( ?: j. h9 w' won markets over the next few years. Even as Canada recovers
7 B; y$ P3 n v4 C& V: P9 _from the cyclical downturn, house price growth will9 w. i5 x }+ Y$ W; `1 o
remain choppy and new residential construction will be0 s V8 p4 G5 A# c
dampened, owing to this structural weakness. Construction" k1 _* ~3 U Z8 F8 [2 y" m6 F
is now undershooting fundamentals and we expect this
0 J5 G7 L& G2 m. h- hto persist over 2009 to 2011. We anticipate that nationwide$ V t4 K" P# |" ~! T& s
residential construction will fall further to around
; s3 U1 G3 [( n& w/ u125,000 starts over 2009 with a trough around 115,000 units$ I H( ~5 _% L' q* w- }7 ?# F3 A
in the fourth quarter.# }" Q' G# `" S f$ Z% k
To quantify the degree of overpricing and overbuilding,
8 q1 @3 V& g: B5 g2 O/ xwe first develop an empirical model, based on long-run' |3 g% A' c+ O( K+ @
fundamentals of house prices and housing starts in each
" m w- N$ F" K7 ^! c4 I: N" o9 ~province. Affordability is the key concept behind home
Z, P+ w- p7 q c& `* `- Zvalues since house prices should track incomes over the
! x8 P5 p/ j' l+ l; u& L! A& Hlong-run. Since homebuilders build to meet demand, we
3 Z+ E* P# @& C9 J) g; @5 lregard housing prices and household formation as the drivers
+ t0 B' x) U* @! F2 Iof residential construction.1 O3 R5 n9 v9 @& I" \
To examine the degree of overbuilding, we employ a' U5 j* f) o* K" z1 i
“counter-factual,” asking what level of residential construction, T0 M" |3 u$ x1 q8 }, O6 Y
would have occurred if housing had been priced7 H4 D% ]. Z4 [) D
optimally. We find that actual homebuilding exceeded this
- X, X4 X! g% Afundamental-justified level by about 12%. Although new- y2 Q% q# S- J/ X+ |6 x2 {- j
units were being absorbed, homebuyers simply bought too
m6 m3 V D8 e! m9 e& Q8 U. |/ l( Xmany houses at prices that exceeded fundamentals.
1 g: _' b% _; L- F3 cRegionally, we see the greatest strains on the Prairies,2 Q/ _; ^ U! ~& j2 B1 ?
where housing demand will further contract under waning
5 E1 y" w$ }+ i3 u! Ypopulation inflows. Saskatoon, Calgary and Edmonton are
( m* a% a% J, Q- m' u1 B' `7 ualready witnessing surges in their unsold new homes at the3 _: m# {# }# o1 T
very time that the resale market has swung into strong
5 e4 T& j* ] U! X* h9 Jbuyers’ territory. Homebuilding in the Atlantic provinces1 T; [1 f& G; [+ V9 w9 k+ z e
has been relatively balanced but, while not plagued by structural
" |1 V! N/ u# j, xweakness, will be singed by the downturn nonetheless.$ F7 m9 E0 D' _
Québec shows signs of strain – especially given the
9 K7 f5 s |/ estrange accumulation of unabsorbed multiples on l’Île de. e5 u3 e# ?" w3 H: {
Montréal – but recent building has been relatively balanced,
7 `/ K+ Q9 z2 |* y$ p Ggiven the province’s history of under-building and low ownership3 J" [! b% a" b/ p
rates. While Ontario homebuilding will reel from a, `4 d: U* q* F
cyclical downturn, the degree of structural weakness appears
i& D' ?7 L- {2 s2 mlimited – with the important exception of the Toronto
0 d6 p q$ k( x! e$ k S# O# z6 jcondo market. Both in Toronto and Vancouver, historically
$ x; {, C# k* m; Mhigh levels of apartment-style units presently under
H( `0 ?6 a7 Econstruction mean that record numbers of condos will
1 ^8 D, s5 z% ?, S& ~reach completion during 2009. If absorption rates fall, as* h% i" Y/ S. b" K
cyclical factors would indicate, condo inventories could
. q* R. ^- E _6 _9 _# M7 lspike severely – particularly in Vancouver. However, while
( \- B5 ~4 ^' rresidential construction in B.C. will definitely droop, we
7 B9 N- D( f7 eanticipate that the West Coast will continue to benefit from. [+ O! d4 p/ `% X, K7 ?( G
inter-provincial and international migration over the coming* I. y X* e( s$ F. M
years, which, along with improvements in affordability,6 ~9 L4 F2 }0 S* _9 {. ^
will alleviate some of the pressure from overbuilding.
1 x1 t0 _) T: yOVERPRICED AND OVERBUILT: CANADIAN HOUSING7 p+ {! |& ~3 L3 r' z
MARKET RETURNS TO FUNDAMENTALS6 r$ `, r, b6 O$ e: Y. b! I9 }
Grant Bishop, Economist
6 A# l2 w! n; R8 f2 B416-982-8063
3 K7 U/ E: r" u4 O3 CPascal Gauthier, Economist+ E ]4 ]! G' Y4 [; l7 f% d
416-944-57307 O3 L& `7 f; K# [, t
6 M% M. O9 N$ s8 f J4 ]5 i
http://www.td.com/economics/special/gb0409_housing_exec.pdf |
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