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During Canada’s “Housing Boom”, which ran roughly
( {! B; B5 O; s) S) y! c4 _% Sfrom 2002 to 2008, unsustainable price increases drove6 I' o, V' E" P. j+ N+ M
unsustainable levels of building. Our view is that house+ i; i: i# a+ A, P4 T# h' G
prices exceeded the value of housing that was justified by- g/ [9 g) b- C$ ~8 |7 A) j( D, b
fundamentals by approximately 9% nationwide. This# {5 s. ?- W5 i: k% X& j& w0 f0 J
overpricing compelled a level of residential construction( f3 M' E2 C( u: B2 Z
that exceeded its fundamental-justified level by approximately' \2 L( Z% d& a6 t) b* q
12%, an excess that was exaggerated in the past
1 T/ w! Q1 l( r% X& ^# U7 e4 t$ qthree years./ m2 C0 \6 K* Z* m+ W) j# R: H l
By “overpricing” we mean that prices detached from
; S! E% k5 ^% {5 d! M. K9 T# _their fundamentals, as witnessed by a steep erosion of2 v9 j/ _- g2 S
affordability. The current unwinding of house prices reflects2 H; O Y- T" c! {
both a cyclical downturn and a return of house prices( L. {+ ]7 X6 Z* S( |
to fundamentally justified levels./ |3 m; c9 F8 C. x/ t( r
We consider “overbuilding” of two forms: “demanddriven”# _$ ^. p) l: @. |1 @9 n& ^( k! n
where homebuyers buy up too many houses and
% ^2 H6 ^, f9 J/ zthat this demand cannot be sustained; and “supply-driven”
9 F; ], B6 j0 s1 S/ v! U6 @where builders accumulate excessive inventories. Although& p, C) c* w) K5 C; i
there is evidence of both types, we contend that Canada’s
3 }4 K+ L$ U, s8 s3 x“overbuilding” was mainly of the first type, where2 e) x( H1 r" J6 R" H
homebuyers pushed homebuilding to an unsustainable pitch5 _4 t* v! ?& |" Q v1 r2 j8 L
that is now being rapidly reined in.& S: j& V/ j1 j8 v( v7 x! w" H$ `
While most markets won’t face U.S.-style overhangs,+ m) t) y1 y+ b1 K/ _
the construction of too many new homes over the boom Y0 K: X# {% d& A1 P4 G
means a deepened slump. This overbuilding will likely weigh: E5 y V" `5 k* v: [$ L
on markets over the next few years. Even as Canada recovers
+ i* R6 i2 v5 ^$ w! d& g% Afrom the cyclical downturn, house price growth will- b) V$ _, H. q& ?( ]
remain choppy and new residential construction will be
1 [0 ]4 P+ V2 O2 b0 u* `/ sdampened, owing to this structural weakness. Construction
* c/ p- T# |7 c' d! N0 p; ]is now undershooting fundamentals and we expect this
0 @! _. w1 g' Z8 {) [5 _5 \) Hto persist over 2009 to 2011. We anticipate that nationwide
v+ I! S; y; _, ?1 U) n. T& hresidential construction will fall further to around6 R* S1 v8 f6 J5 U0 J- ^. O$ C
125,000 starts over 2009 with a trough around 115,000 units
X0 o8 p) u& P2 r4 V# @in the fourth quarter.$ h0 Y7 x) r6 K) p- R7 `! Y0 L
To quantify the degree of overpricing and overbuilding,
! I5 f* C- a# `' U! m Cwe first develop an empirical model, based on long-run
+ s2 c) I, ~9 M# ?9 dfundamentals of house prices and housing starts in each
0 C- L8 j" l' w& Mprovince. Affordability is the key concept behind home
! B) ]0 `4 j X% x7 ^: Qvalues since house prices should track incomes over the
% r( T9 q) K r, L, h, ^long-run. Since homebuilders build to meet demand, we
: F" _/ e% \1 [4 T5 h6 mregard housing prices and household formation as the drivers3 o+ i, _; Z/ B2 E" K+ a# B5 s
of residential construction.
* n: z) `+ z; k8 M. k2 F! q2 GTo examine the degree of overbuilding, we employ a
& C. L5 H# [. ^' w; C( _“counter-factual,” asking what level of residential construction& L0 t) l6 o& f$ V: p
would have occurred if housing had been priced
. v8 e3 ? R& {. woptimally. We find that actual homebuilding exceeded this5 I' [% p/ Z9 N0 U9 A8 @
fundamental-justified level by about 12%. Although new
I3 X! P/ J$ B% sunits were being absorbed, homebuyers simply bought too1 v4 r; w- R1 Z8 f5 v* r
many houses at prices that exceeded fundamentals.
! ~" v v0 [' a; pRegionally, we see the greatest strains on the Prairies,
: H' ^2 j8 Q. [6 ^where housing demand will further contract under waning: K) h k/ [' ~- b9 g/ {
population inflows. Saskatoon, Calgary and Edmonton are/ l1 N* e3 Q1 {0 d! z: e A
already witnessing surges in their unsold new homes at the% u2 t- K6 K# U+ z. j9 \
very time that the resale market has swung into strong! B3 w, d/ s& x5 S6 I& r
buyers’ territory. Homebuilding in the Atlantic provinces4 t7 |* d! F+ A! v; h6 l( N
has been relatively balanced but, while not plagued by structural
* E5 ~. U, F) mweakness, will be singed by the downturn nonetheless.! U! x+ ^9 G+ W* R4 a u) r
Québec shows signs of strain – especially given the: |7 f. F; H- t
strange accumulation of unabsorbed multiples on l’Île de
+ H# a7 k4 z7 e, N; z3 M9 W$ SMontréal – but recent building has been relatively balanced,
$ y" w, y" V( I9 D, B+ n1 N8 b* Mgiven the province’s history of under-building and low ownership; G4 T+ z, v) _/ s7 _3 B2 Z+ g
rates. While Ontario homebuilding will reel from a
4 Z; o; o3 c' xcyclical downturn, the degree of structural weakness appears, R7 z, ]& P$ g6 ?. k7 n
limited – with the important exception of the Toronto9 j0 l) W! t& P% o/ }
condo market. Both in Toronto and Vancouver, historically
0 c- l4 f J& H- X2 lhigh levels of apartment-style units presently under
5 z& |2 Z. W6 X @7 G; Q1 kconstruction mean that record numbers of condos will3 o3 U+ d8 ^5 `) S
reach completion during 2009. If absorption rates fall, as
. E# d y; q2 j. `7 q3 Acyclical factors would indicate, condo inventories could
; S/ X. O9 J% Kspike severely – particularly in Vancouver. However, while x1 b% O) y' v8 y f) W
residential construction in B.C. will definitely droop, we
9 x* |( t" t* x. ?4 j$ U7 O6 R+ m$ fanticipate that the West Coast will continue to benefit from
# y) G$ W- {8 `9 e! }inter-provincial and international migration over the coming" S ^8 s9 d1 E' @, G" l3 L
years, which, along with improvements in affordability,
0 c. T+ h3 R. |2 a+ \) v0 kwill alleviate some of the pressure from overbuilding.
- i2 y. @7 i* c3 S+ p# E4 mOVERPRICED AND OVERBUILT: CANADIAN HOUSING) p7 X" p' V; a% d8 B( A
MARKET RETURNS TO FUNDAMENTALS
" O8 e4 c5 @* M4 cGrant Bishop, Economist
; w B; R1 T' o; ~6 C416-982-80639 l+ N2 h- v# ~* l0 d! x& P2 @: |
Pascal Gauthier, Economist0 D6 ?* \& X9 v1 B C4 e4 f6 p
416-944-5730
* h. N) E: j' t
: m' f8 ~$ j! M! z8 ahttp://www.td.com/economics/special/gb0409_housing_exec.pdf |
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