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During Canada’s “Housing Boom”, which ran roughly
& X" ^; F. d* f3 ]from 2002 to 2008, unsustainable price increases drove5 O1 n0 O# {2 b& C3 J
unsustainable levels of building. Our view is that house# m3 [. Y ~! {1 S9 ^
prices exceeded the value of housing that was justified by5 \# Y) |# Z# d, A
fundamentals by approximately 9% nationwide. This2 s4 N2 b1 y8 E0 j3 \8 B8 h; t4 n
overpricing compelled a level of residential construction
4 o3 } ^* f$ e1 R$ Fthat exceeded its fundamental-justified level by approximately
! P) \( x5 ]7 d, _- D12%, an excess that was exaggerated in the past6 f6 L& I9 K4 T" p1 ?0 q
three years.
# J0 P$ H) b0 e5 H0 gBy “overpricing” we mean that prices detached from
3 |& Z( y* ` Q/ q3 C5 i1 wtheir fundamentals, as witnessed by a steep erosion of8 q$ Q8 z4 n& {' s" ?) b8 J t
affordability. The current unwinding of house prices reflects
3 y: i& X' R! J" S% n5 Fboth a cyclical downturn and a return of house prices
- V1 U. J3 H/ A3 Q0 M: g- [to fundamentally justified levels.) n; Q& { x* |, i. ?8 z* U+ y% a' [ f6 h
We consider “overbuilding” of two forms: “demanddriven”
9 m3 @& q, l1 y' U5 u$ Q, K1 Awhere homebuyers buy up too many houses and* R& t8 |, A2 a
that this demand cannot be sustained; and “supply-driven”
9 _0 E, ?1 V+ M+ J1 {where builders accumulate excessive inventories. Although! _1 v0 ?8 U: K( A( G; n0 o
there is evidence of both types, we contend that Canada’s
' f0 k) d% q8 y, s& p“overbuilding” was mainly of the first type, where
0 ?9 q$ D5 `* }+ |1 v1 ~homebuyers pushed homebuilding to an unsustainable pitch
% f8 d- [& n5 `$ q6 athat is now being rapidly reined in.
) t% D6 U* G9 mWhile most markets won’t face U.S.-style overhangs,9 p* o- {. Y/ Q/ {8 V) n/ H6 {
the construction of too many new homes over the boom! j2 Q# b+ d4 q% G4 s+ n
means a deepened slump. This overbuilding will likely weigh
4 \9 T8 T( C/ z% ~9 X6 U' c. Q* zon markets over the next few years. Even as Canada recovers* g9 a; e. M# `- K/ O" l0 T: [
from the cyclical downturn, house price growth will* D- l) ?4 h" p6 r/ O
remain choppy and new residential construction will be
; @% M Y+ ~7 p7 R! Z5 L9 ~. y" Tdampened, owing to this structural weakness. Construction. `8 z R; | O% m. C% S3 i
is now undershooting fundamentals and we expect this1 Q2 X: A# B8 M% I; w$ K9 e9 T" L
to persist over 2009 to 2011. We anticipate that nationwide9 P2 w8 \/ Q) v
residential construction will fall further to around0 ?7 ]9 q4 a( f5 g
125,000 starts over 2009 with a trough around 115,000 units0 Z: e5 o+ c" A# u
in the fourth quarter.
) ~, ?2 n, `' \' V: n2 `4 S2 wTo quantify the degree of overpricing and overbuilding,
2 i3 X. j. Z8 b. e& Mwe first develop an empirical model, based on long-run
* S! k, Q6 b ofundamentals of house prices and housing starts in each
$ @+ {$ m$ G+ u2 Pprovince. Affordability is the key concept behind home- a# b1 U( r- S$ W! L( {& [
values since house prices should track incomes over the
+ W: {. I; [0 X1 \$ |2 _+ ~ Qlong-run. Since homebuilders build to meet demand, we
8 ^) h# v9 ~: H0 B! B! tregard housing prices and household formation as the drivers1 \7 K: B( `- } ]6 @
of residential construction.5 H! _" K& I8 z$ H! _
To examine the degree of overbuilding, we employ a3 B, D$ I# r4 A
“counter-factual,” asking what level of residential construction
* m5 D7 }2 S' e ^would have occurred if housing had been priced
- z3 _' A8 [5 O# qoptimally. We find that actual homebuilding exceeded this
5 L( v6 c g6 ]2 X$ N9 ufundamental-justified level by about 12%. Although new
" D( S8 D: v8 j7 aunits were being absorbed, homebuyers simply bought too: \ W$ b/ o8 G
many houses at prices that exceeded fundamentals.
% u) D5 P$ ]1 W" T5 @2 R3 URegionally, we see the greatest strains on the Prairies,
+ C9 i) \7 ^. _1 kwhere housing demand will further contract under waning
) W0 T; A; w/ B$ B* K- {7 ipopulation inflows. Saskatoon, Calgary and Edmonton are" c6 Z _/ `1 y% W% ?; ?( t
already witnessing surges in their unsold new homes at the1 C3 X& c2 Z- q. l4 C
very time that the resale market has swung into strong2 V8 C4 Q: D p
buyers’ territory. Homebuilding in the Atlantic provinces6 D6 G0 e# Q8 k& t% g
has been relatively balanced but, while not plagued by structural! U* z8 E5 T. X4 z$ A- t7 K
weakness, will be singed by the downturn nonetheless.
5 u$ O; x$ R1 j+ w4 iQuébec shows signs of strain – especially given the% {3 H T r ]$ L0 R0 _$ z) K/ g
strange accumulation of unabsorbed multiples on l’Île de7 C; d# N1 O' c
Montréal – but recent building has been relatively balanced,
* @+ `# F1 t V* F/ Y* Ugiven the province’s history of under-building and low ownership
- ] n, r/ B* Q! p& Prates. While Ontario homebuilding will reel from a- {5 Z7 R: {5 u. G; I, \
cyclical downturn, the degree of structural weakness appears
5 B5 L# J. ^% J9 Y. C% ~# Tlimited – with the important exception of the Toronto8 `" }3 k% _0 i7 d B5 E! P
condo market. Both in Toronto and Vancouver, historically( K9 s- G% X8 g1 a# z# N- T1 l1 Z
high levels of apartment-style units presently under
1 C3 u. Z1 m9 O/ z7 j7 _. Yconstruction mean that record numbers of condos will6 B# v1 E! w3 \4 X- {
reach completion during 2009. If absorption rates fall, as
; P4 J# r- @. t8 S9 }: u7 I# s: `cyclical factors would indicate, condo inventories could( i$ A4 A8 |1 B/ @* O7 s+ p
spike severely – particularly in Vancouver. However, while
* p% j a( D6 a; `4 Xresidential construction in B.C. will definitely droop, we
8 C7 s |) z6 R Y+ |) }anticipate that the West Coast will continue to benefit from
B/ l/ U" F0 V7 g1 v6 \inter-provincial and international migration over the coming v& Q: s9 Q7 s1 I8 ?' m+ O( z8 M
years, which, along with improvements in affordability,% }9 h5 I P6 _' M! ^
will alleviate some of the pressure from overbuilding.
# w* G( ]8 c# e+ o; g5 {2 |5 }OVERPRICED AND OVERBUILT: CANADIAN HOUSING
' U* P8 h q' v( y3 {, [MARKET RETURNS TO FUNDAMENTALS' N5 a+ D( i) m/ \4 l g- ^
Grant Bishop, Economist
9 ~1 O$ j' o& }, t, j416-982-8063
; a1 W) H `! n6 oPascal Gauthier, Economist
; i9 A& v, o8 q; S7 Y5 c d2 q1 R416-944-5730
6 {6 X4 x- r3 _% H! J, [9 }* c- u7 f
http://www.td.com/economics/special/gb0409_housing_exec.pdf |
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