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During Canada’s “Housing Boom”, which ran roughly
' H3 b% u0 X7 x+ C' f5 v# a4 Zfrom 2002 to 2008, unsustainable price increases drove
; J4 b/ T( U- B) dunsustainable levels of building. Our view is that house
" T9 ?) t e. l) ^prices exceeded the value of housing that was justified by
* L5 O( {: @$ xfundamentals by approximately 9% nationwide. This
0 f! k k& @4 i9 M( I/ f; g( D: poverpricing compelled a level of residential construction
. _1 F2 V6 D5 k# }* gthat exceeded its fundamental-justified level by approximately5 A5 ?0 x$ V& x$ e1 q- }8 {2 M
12%, an excess that was exaggerated in the past1 |7 B2 B+ A* A/ K4 T2 T! F: K
three years.
+ b; |! T9 u3 Z( J5 w2 Z# J- U4 jBy “overpricing” we mean that prices detached from
' J, }3 N& c: j S0 Otheir fundamentals, as witnessed by a steep erosion of
3 N. s: n1 x) ] Waffordability. The current unwinding of house prices reflects3 c s& g1 _1 C5 l' M3 p
both a cyclical downturn and a return of house prices
! n% X) _& V6 h7 o; f3 H) R/ @to fundamentally justified levels.
5 l) T! P' b- |7 P: z' l$ RWe consider “overbuilding” of two forms: “demanddriven”
w* F" q h* B: y2 ^+ ~where homebuyers buy up too many houses and
* z5 t: H/ A& C! l. pthat this demand cannot be sustained; and “supply-driven”
4 j) l; H) }& }* ~0 }where builders accumulate excessive inventories. Although
/ t9 n- `: L1 z7 h2 d: Kthere is evidence of both types, we contend that Canada’s; T* |! i! A, I
“overbuilding” was mainly of the first type, where
" {' }9 w, |. }: }homebuyers pushed homebuilding to an unsustainable pitch
1 Y/ C3 A& y( ~that is now being rapidly reined in.9 m7 j( a3 S! j( ]( ~
While most markets won’t face U.S.-style overhangs,
6 f: I8 Q3 P8 p; t3 M3 Sthe construction of too many new homes over the boom
- R7 c/ O% u9 Dmeans a deepened slump. This overbuilding will likely weigh Z9 k2 Y1 p+ z* |8 ?
on markets over the next few years. Even as Canada recovers8 G( D1 }; X0 ?2 h
from the cyclical downturn, house price growth will$ G( @3 E1 E. g3 ]5 X* I! m
remain choppy and new residential construction will be
/ p$ |1 U& @# U9 [: Z0 e7 N6 Ddampened, owing to this structural weakness. Construction/ e" u- A! N0 X# O& Y* E7 P
is now undershooting fundamentals and we expect this
4 F3 [2 \1 _) t% A _+ lto persist over 2009 to 2011. We anticipate that nationwide; I$ a8 m- Y/ V- K
residential construction will fall further to around
) A( J' p& l0 _; p1 n. r125,000 starts over 2009 with a trough around 115,000 units. S2 x. E# g7 L4 _9 @5 W
in the fourth quarter.7 j0 {7 n# H2 k4 q7 f
To quantify the degree of overpricing and overbuilding,& E( J) C' k3 e, a6 O
we first develop an empirical model, based on long-run8 e1 K* P+ b# R/ `
fundamentals of house prices and housing starts in each1 u4 s6 l' b' @3 B, W
province. Affordability is the key concept behind home
8 | j; t4 O6 ]* E1 X! [values since house prices should track incomes over the h& T$ J! H8 _; y' G" Y8 q
long-run. Since homebuilders build to meet demand, we
# |' A7 L1 y( @$ sregard housing prices and household formation as the drivers; m; K+ e8 B0 j# H* A
of residential construction.4 {) J" O6 U0 r& Y: @& f
To examine the degree of overbuilding, we employ a
& k* @- @! s3 d# I7 s9 c$ k6 n“counter-factual,” asking what level of residential construction4 B' Y& M; Q0 F9 _( S
would have occurred if housing had been priced* U& S7 c+ m: W# n: ]% |
optimally. We find that actual homebuilding exceeded this
6 y$ A, K2 J7 `" F4 s H4 s/ wfundamental-justified level by about 12%. Although new% U, s# T! r, P3 Y* g! L% L9 U9 u% y
units were being absorbed, homebuyers simply bought too$ S2 f" Q; c$ @3 O9 P0 c
many houses at prices that exceeded fundamentals.
1 Z9 x# H" {1 r# ?# Q# y$ yRegionally, we see the greatest strains on the Prairies,
, S9 y2 i& l q+ B, Twhere housing demand will further contract under waning4 ~- v8 ~, V. Y9 N. q( b
population inflows. Saskatoon, Calgary and Edmonton are
/ A- G7 ^' Z* V: t4 b6 h* E- Galready witnessing surges in their unsold new homes at the- N0 O7 F: |7 G0 N, t( d4 q9 Q
very time that the resale market has swung into strong8 l% d, b; Y+ g6 z* `' b
buyers’ territory. Homebuilding in the Atlantic provinces0 u2 {# h! d1 s( N& R
has been relatively balanced but, while not plagued by structural/ s1 M' ~) q( U' Y
weakness, will be singed by the downturn nonetheless.
; J7 z6 ?1 O M7 V7 a/ IQuébec shows signs of strain – especially given the
( l" U+ c$ z- @" Z6 Kstrange accumulation of unabsorbed multiples on l’Île de
$ `6 T( p9 z( o# eMontréal – but recent building has been relatively balanced,1 @4 O7 M! Y+ M+ S! ?, G
given the province’s history of under-building and low ownership
& D5 v. g2 d5 r+ n! {* t9 ]rates. While Ontario homebuilding will reel from a
, ]; I. q% i7 Y+ f) F+ T Ucyclical downturn, the degree of structural weakness appears
0 n4 U% w1 \; @* N# x2 }limited – with the important exception of the Toronto
0 \) J& a% d# S* J4 E, ^$ Ycondo market. Both in Toronto and Vancouver, historically9 |" \) N6 L) M* o. a! r
high levels of apartment-style units presently under
6 r$ \+ a/ Y" zconstruction mean that record numbers of condos will. N5 Y* H# J$ P; [3 D
reach completion during 2009. If absorption rates fall, as
; v b7 ]2 D" Acyclical factors would indicate, condo inventories could
" {; `3 p3 z+ f" Xspike severely – particularly in Vancouver. However, while6 I$ Y% I" H4 e, F8 p3 r
residential construction in B.C. will definitely droop, we: g7 |) {* x: ?2 E
anticipate that the West Coast will continue to benefit from0 t- h2 ?) ^3 p5 q! H: }; ^8 b
inter-provincial and international migration over the coming
$ @; E6 F$ P& s5 X6 qyears, which, along with improvements in affordability,
W4 ~& d1 O7 h3 A/ K8 lwill alleviate some of the pressure from overbuilding.
( N0 Z1 E* E5 R" kOVERPRICED AND OVERBUILT: CANADIAN HOUSING* b2 {) a- C: x9 y9 {( J$ \2 J6 `
MARKET RETURNS TO FUNDAMENTALS
! |* p3 I7 L w* u" IGrant Bishop, Economist
1 l' M+ G' m) X( f& j7 ^416-982-8063
- g; w7 m, g2 l7 J+ q* vPascal Gauthier, Economist" F5 m) W; c2 K
416-944-5730
* R) [6 T' S6 Y! T$ w. o) m
2 i E+ q2 i! E t' H" W/ Nhttp://www.td.com/economics/special/gb0409_housing_exec.pdf |
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