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During Canada’s “Housing Boom”, which ran roughly
6 y; X' y1 T8 j) E1 C7 tfrom 2002 to 2008, unsustainable price increases drove( R! I8 C4 `9 c% t* p0 b
unsustainable levels of building. Our view is that house
; V$ K& f( F1 @4 u" S/ l; B0 {9 v, ^prices exceeded the value of housing that was justified by
) [! w# l v+ }5 [fundamentals by approximately 9% nationwide. This# N+ W5 c; O+ O9 n9 M
overpricing compelled a level of residential construction; U) q# V1 c# I& J! a) Y( Y
that exceeded its fundamental-justified level by approximately
/ f7 S* }) |2 u2 z12%, an excess that was exaggerated in the past, Z9 M* ]) X6 o
three years.& F+ Z! e' {( ]/ P( g4 A3 G/ j
By “overpricing” we mean that prices detached from |7 n0 u) d" H0 U
their fundamentals, as witnessed by a steep erosion of6 j9 r8 ]( Q( y0 Z3 e
affordability. The current unwinding of house prices reflects; h. Q5 S7 [2 ]# c; r5 e' u4 V3 t
both a cyclical downturn and a return of house prices2 q* [5 `9 e- W3 z5 I8 p0 S
to fundamentally justified levels.
0 ~# m" \4 }+ ]3 NWe consider “overbuilding” of two forms: “demanddriven”
7 [' l8 Y x1 t# q5 e" `0 r2 [where homebuyers buy up too many houses and( j" _2 J+ W8 h" r7 l j
that this demand cannot be sustained; and “supply-driven”5 i" K; u1 e, H- b! W
where builders accumulate excessive inventories. Although5 l5 Z) l& g9 A) j
there is evidence of both types, we contend that Canada’s
5 Y2 ?4 ~' f2 l$ _/ _“overbuilding” was mainly of the first type, where; a* I3 n1 G! D% B% z$ |
homebuyers pushed homebuilding to an unsustainable pitch( T( Y& Z8 c+ ^8 v- @- Q1 J
that is now being rapidly reined in.
. O: H) {! B) J7 eWhile most markets won’t face U.S.-style overhangs,: r# U* g2 [+ f8 i" L
the construction of too many new homes over the boom
& Z m* t$ `6 h J; wmeans a deepened slump. This overbuilding will likely weigh) ^! _& B: s% \! t/ N, e
on markets over the next few years. Even as Canada recovers
# D7 ]$ `9 I% s( ifrom the cyclical downturn, house price growth will
0 I. i1 d. N. C; A Fremain choppy and new residential construction will be
& |5 I2 R6 a0 ddampened, owing to this structural weakness. Construction; t4 c/ G3 S( b
is now undershooting fundamentals and we expect this
7 n7 N6 r" K% p- J) C$ Ito persist over 2009 to 2011. We anticipate that nationwide
2 t+ J& o$ x9 b* dresidential construction will fall further to around+ ~* u( V: j6 {$ R' @7 ?% z
125,000 starts over 2009 with a trough around 115,000 units
, q/ ]3 k; ^+ _in the fourth quarter.
) n0 J/ I# F. |To quantify the degree of overpricing and overbuilding,: L: T) e7 s8 p3 \, q( _# y. W6 t! m' d
we first develop an empirical model, based on long-run
% C2 V6 ^$ I/ Z/ N. F% vfundamentals of house prices and housing starts in each6 {% f0 c7 |$ _* b
province. Affordability is the key concept behind home$ a& i# Z' N8 |; S
values since house prices should track incomes over the
2 M" M; t& L$ Y# Ilong-run. Since homebuilders build to meet demand, we
! g2 z: Z& g8 q5 o' ~regard housing prices and household formation as the drivers
3 l. F# n& k b- z" j8 sof residential construction." G$ k4 h+ u+ p/ ^
To examine the degree of overbuilding, we employ a( g2 g5 m! |0 d
“counter-factual,” asking what level of residential construction+ e; }4 M+ H; r! L( O; U
would have occurred if housing had been priced4 z& p$ r' x& k! F0 l4 P" ]. G# u
optimally. We find that actual homebuilding exceeded this
5 `/ f: u) |) x! H$ y( Mfundamental-justified level by about 12%. Although new
+ p: z: Z6 g9 g6 r6 X9 s Munits were being absorbed, homebuyers simply bought too, k T: H1 A' Q; w( A: p3 g) N
many houses at prices that exceeded fundamentals.) v% M4 N6 B8 [: k$ S* b
Regionally, we see the greatest strains on the Prairies,/ O1 k# t* W" c4 i, w4 _
where housing demand will further contract under waning
+ @5 [" |7 a; Q" V) ~8 zpopulation inflows. Saskatoon, Calgary and Edmonton are# Y8 D* ~4 Z- X" j a9 `3 I8 Q
already witnessing surges in their unsold new homes at the" r* s/ \; ~ J$ ^. d
very time that the resale market has swung into strong! c2 {5 `1 O! W. F0 e7 B, u
buyers’ territory. Homebuilding in the Atlantic provinces9 O4 ~$ | A% R, U; }, B; v
has been relatively balanced but, while not plagued by structural
4 f' N4 ^& Q5 qweakness, will be singed by the downturn nonetheless.
1 V, h2 ?9 @# {$ c2 {4 {. fQuébec shows signs of strain – especially given the3 ~2 @& F7 \ Z" h$ L- J0 C. ^
strange accumulation of unabsorbed multiples on l’Île de0 ?# b& Z Z# w- `: q# Q
Montréal – but recent building has been relatively balanced,5 @. O/ b# A+ ]) @
given the province’s history of under-building and low ownership5 [9 i X2 d4 i% o7 X
rates. While Ontario homebuilding will reel from a
7 I7 r1 a2 k' zcyclical downturn, the degree of structural weakness appears
. Y/ h9 x' h! L8 g% Llimited – with the important exception of the Toronto
1 Q# H# }/ s# t3 _condo market. Both in Toronto and Vancouver, historically
8 n4 b# l( i7 l3 [high levels of apartment-style units presently under
, {) b. I- W. V H1 [construction mean that record numbers of condos will
# C2 n; P8 B# q6 E8 ]' E6 Nreach completion during 2009. If absorption rates fall, as
2 @8 R1 i; h9 K( Hcyclical factors would indicate, condo inventories could& ^* \4 W0 d# y6 d5 H7 Y
spike severely – particularly in Vancouver. However, while( C9 x. @' k; f6 M6 L$ V% u
residential construction in B.C. will definitely droop, we0 Z0 X: z: z# ?6 T; ^- S" [$ o
anticipate that the West Coast will continue to benefit from
% `0 O* J( l+ _+ z `/ i$ Q4 Minter-provincial and international migration over the coming
& I% n7 ~% b9 `# ^years, which, along with improvements in affordability,
v! U3 ]( X' W4 qwill alleviate some of the pressure from overbuilding.0 @- t" E1 G# k5 A
OVERPRICED AND OVERBUILT: CANADIAN HOUSING6 U8 m9 q; x8 Q5 o0 L. h
MARKET RETURNS TO FUNDAMENTALS# a, z3 l4 ]- ^
Grant Bishop, Economist
7 v, S' m* o& w9 e8 x1 V, n; |416-982-8063
. g' g8 W- y4 WPascal Gauthier, Economist4 A p, R. ^ |0 m; a- M
416-944-57301 q( B2 H$ F: ^ l# }
4 v+ U; I* P- {7 I2 Vhttp://www.td.com/economics/special/gb0409_housing_exec.pdf |
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