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During Canada’s “Housing Boom”, which ran roughly
( ]; V) Y6 P$ Y: V, w& K' h% G- j# zfrom 2002 to 2008, unsustainable price increases drove
_/ n4 T, n) C: |! J h4 xunsustainable levels of building. Our view is that house
! K' W1 Y# y* ?# z8 e# V' w. P9 ] ?prices exceeded the value of housing that was justified by: J/ i/ l# B- Z6 { ~% e
fundamentals by approximately 9% nationwide. This9 n2 d, L) u5 ]- ?
overpricing compelled a level of residential construction
5 i0 L- q6 h- K8 i# F8 bthat exceeded its fundamental-justified level by approximately
, J) t7 _7 [5 a% g* x12%, an excess that was exaggerated in the past
0 m# U6 a2 @ Fthree years.
# ?' z; p$ ?0 {4 s4 h% Y N k! L. dBy “overpricing” we mean that prices detached from
" d6 V7 x) E4 Htheir fundamentals, as witnessed by a steep erosion of
( }# I& e: T/ E: S% y& Q2 {affordability. The current unwinding of house prices reflects
. J j+ J7 d e$ lboth a cyclical downturn and a return of house prices. C3 c/ T T: D
to fundamentally justified levels.% y7 _/ l& T2 I/ O) r9 D% l
We consider “overbuilding” of two forms: “demanddriven”$ ~4 F4 B6 P1 ~ x7 ?
where homebuyers buy up too many houses and
' _$ H+ t7 q! {' Athat this demand cannot be sustained; and “supply-driven”
; I' W- [, j4 J$ Lwhere builders accumulate excessive inventories. Although
8 A$ |* Z0 `5 W, M+ M3 O; Ithere is evidence of both types, we contend that Canada’s
- Q* Z, L4 O& j V! E* F“overbuilding” was mainly of the first type, where
' }1 O8 u" i8 p3 u2 V0 j. Nhomebuyers pushed homebuilding to an unsustainable pitch4 q! F7 J& u, C/ O
that is now being rapidly reined in.# c" h8 U- F) ?& p8 y9 t9 |) }, m8 L/ v
While most markets won’t face U.S.-style overhangs,
; Y4 w3 f* ~, athe construction of too many new homes over the boom
) @0 H1 A7 @6 S D" I3 n2 wmeans a deepened slump. This overbuilding will likely weigh
1 ~9 c `& z. z7 `, Mon markets over the next few years. Even as Canada recovers
/ B. q' _" E4 I: F7 |/ G* {from the cyclical downturn, house price growth will2 a4 X9 F0 L' D3 ` k
remain choppy and new residential construction will be
5 P5 d) t: z6 I( W y+ ^dampened, owing to this structural weakness. Construction
& b0 E8 y2 W2 s& q; kis now undershooting fundamentals and we expect this
9 u% D$ L& g- x, ]( lto persist over 2009 to 2011. We anticipate that nationwide
7 F X2 G. ~3 @. ], l3 _9 |* Xresidential construction will fall further to around
$ V6 x+ r Y9 ~4 B125,000 starts over 2009 with a trough around 115,000 units
+ k& h. b1 d! ] Tin the fourth quarter.
8 C! H4 h" u. f4 f S" `To quantify the degree of overpricing and overbuilding,- g" v. r# [6 e6 C4 K! H
we first develop an empirical model, based on long-run" G( G/ t! k! [! \7 a- R7 Z0 g
fundamentals of house prices and housing starts in each/ ?6 A* e. B5 d+ ?, F* v P
province. Affordability is the key concept behind home2 f4 \. V/ H( H) q) i& r% F
values since house prices should track incomes over the
& o, ?& t- [: N$ k; ]+ t. elong-run. Since homebuilders build to meet demand, we
+ e0 Z: i H# \6 Pregard housing prices and household formation as the drivers
9 @; l" {9 T9 r3 W' X5 y5 }of residential construction.
' S' v* W. T1 MTo examine the degree of overbuilding, we employ a0 M# p& F" ?, A9 Z2 L9 ?9 U
“counter-factual,” asking what level of residential construction7 I; D9 h+ e% Z
would have occurred if housing had been priced
6 D% {3 I) [# M( J" |optimally. We find that actual homebuilding exceeded this6 J) a# N5 w* G4 a1 H
fundamental-justified level by about 12%. Although new
) m$ }7 O# o) w; p/ a) v* Uunits were being absorbed, homebuyers simply bought too
9 ` H9 o0 _% lmany houses at prices that exceeded fundamentals.
0 P; Z/ c2 Q1 JRegionally, we see the greatest strains on the Prairies,$ ?0 V0 s9 q1 s2 M
where housing demand will further contract under waning
- ]" S T `% h5 `! spopulation inflows. Saskatoon, Calgary and Edmonton are
- ~! p2 b! [" s+ z, t- P% nalready witnessing surges in their unsold new homes at the! ]: Q- A# ^( z/ ^2 f# [
very time that the resale market has swung into strong
& X, n/ E0 x6 d9 a: X, Y% _; Kbuyers’ territory. Homebuilding in the Atlantic provinces
$ D, X0 Y' B' P3 Z7 Z4 _. s7 [has been relatively balanced but, while not plagued by structural! O: y0 v; L" ?" J, k
weakness, will be singed by the downturn nonetheless.% Y' H$ r) V3 Q2 k' S# D" g* R
Québec shows signs of strain – especially given the' d! M3 g$ A8 C
strange accumulation of unabsorbed multiples on l’Île de4 R- T7 B1 U! j* w B7 o2 N
Montréal – but recent building has been relatively balanced,
! _* v4 @- B6 \" [$ }* Z) O6 tgiven the province’s history of under-building and low ownership8 S0 Q9 j9 j* s! U7 q, K
rates. While Ontario homebuilding will reel from a; d; F% a D8 B. x- P0 `- Y
cyclical downturn, the degree of structural weakness appears
0 u. f8 p/ X5 @/ n8 nlimited – with the important exception of the Toronto
m o( ? R/ d7 _) h$ r. s2 x# J8 [condo market. Both in Toronto and Vancouver, historically
{# F* L, _3 n3 g, Uhigh levels of apartment-style units presently under
7 `2 X/ k6 i, h/ [& |construction mean that record numbers of condos will" s! ]3 f$ `3 R- f
reach completion during 2009. If absorption rates fall, as% n7 ^$ l2 M# i/ Y) w! J4 b$ M" h7 k
cyclical factors would indicate, condo inventories could
+ \# Q" q# u" aspike severely – particularly in Vancouver. However, while; c) n4 D9 t; f3 s. b: e) |) a
residential construction in B.C. will definitely droop, we
z3 c Y6 _* i9 x0 Ranticipate that the West Coast will continue to benefit from
( o/ q( s2 C. H7 @* jinter-provincial and international migration over the coming
# t1 a; e( V& |% Dyears, which, along with improvements in affordability,; ?/ K5 n8 ?6 M" T, R' b& q
will alleviate some of the pressure from overbuilding.+ [; b8 e: ^/ p4 Q# K. l2 S7 K
OVERPRICED AND OVERBUILT: CANADIAN HOUSING! R% I2 @8 @5 {* f K8 r# E$ n
MARKET RETURNS TO FUNDAMENTALS
9 m% H0 B8 i, J9 Z o3 Q" x' F# PGrant Bishop, Economist2 o, Y# _) ^" a* I8 m c. _
416-982-8063
% w" z9 q; G/ s; z! V9 `" n1 aPascal Gauthier, Economist/ V: Z& O- j. X+ g, E6 D; C8 \) f$ Q/ r; B% ]
416-944-5730: _, G& q1 m" Y4 F" D
, m- x" F5 K* k+ G7 L6 n! x; T% ~1 }http://www.td.com/economics/special/gb0409_housing_exec.pdf |
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