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During Canada’s “Housing Boom”, which ran roughly1 ?. r$ |: p0 [9 F
from 2002 to 2008, unsustainable price increases drove
3 A' P3 ~$ r) p7 Y$ @; u/ @5 J4 Eunsustainable levels of building. Our view is that house
+ H: n- F( x3 Y- o" iprices exceeded the value of housing that was justified by
$ L8 w6 ]# b, p1 Cfundamentals by approximately 9% nationwide. This
4 s5 v' Y; g. Z1 G# u* ~: \# Ooverpricing compelled a level of residential construction
e: s% v. j4 n% l' x' K' H' g; Wthat exceeded its fundamental-justified level by approximately
6 D+ {5 p$ o x0 y& w) A$ ~12%, an excess that was exaggerated in the past; m1 A6 y0 t- U4 C+ I$ s
three years.' ]4 M4 @( w$ G' m1 [
By “overpricing” we mean that prices detached from
# {8 N+ L( g5 j8 N: P) r9 @5 I. Ctheir fundamentals, as witnessed by a steep erosion of% `7 y' y2 S. n2 a% C: b, Y- K8 h
affordability. The current unwinding of house prices reflects
. c( p- \" Z' C' P6 jboth a cyclical downturn and a return of house prices
8 V9 O$ Z/ |5 T) Mto fundamentally justified levels.
- z% l2 M4 Z. |0 R6 |We consider “overbuilding” of two forms: “demanddriven”
. \+ _ [3 @3 d- W. {where homebuyers buy up too many houses and
" A6 h% e. \) x8 K: O1 c4 j! qthat this demand cannot be sustained; and “supply-driven”
: N7 e( g; V" e! n( Hwhere builders accumulate excessive inventories. Although
; W% p. F: S, f& r6 Y; `4 X2 Rthere is evidence of both types, we contend that Canada’s& V& C5 H! u, H s+ Y# q! u
“overbuilding” was mainly of the first type, where( S8 ~- S: g" c" s2 [8 j6 A$ m
homebuyers pushed homebuilding to an unsustainable pitch
* J$ B5 a( }, F, \6 e% ethat is now being rapidly reined in., _% m/ Q7 `" K3 v3 \# H
While most markets won’t face U.S.-style overhangs,
/ q; L, g* n9 k' K7 Uthe construction of too many new homes over the boom6 Q" Q, j7 }& x
means a deepened slump. This overbuilding will likely weigh
- O6 v, c! Q" S. _- q+ c2 zon markets over the next few years. Even as Canada recovers
8 A: E1 H4 \; u' Y) f+ S$ tfrom the cyclical downturn, house price growth will
6 F# q0 a0 D+ t/ @# oremain choppy and new residential construction will be% k E1 U: Q3 V2 J
dampened, owing to this structural weakness. Construction
0 F* G# K2 a# K! Bis now undershooting fundamentals and we expect this- z% ~5 ?" b+ L/ \& r! ` V
to persist over 2009 to 2011. We anticipate that nationwide7 b, h: J6 h, |. G9 i) F' U" D
residential construction will fall further to around- d3 X2 e3 s+ m0 h' ` \
125,000 starts over 2009 with a trough around 115,000 units
' l2 ^$ N! B$ g+ Rin the fourth quarter.
7 d' Y( Z4 z3 j4 Z2 NTo quantify the degree of overpricing and overbuilding,
# V5 d, x4 n, Lwe first develop an empirical model, based on long-run
) g5 C8 I" z: M E0 a6 |fundamentals of house prices and housing starts in each7 J+ R8 \+ S6 i$ O9 X$ J* I
province. Affordability is the key concept behind home% M, U8 B8 W! b; O& C O
values since house prices should track incomes over the
n( {5 `( y+ _& U; M( }* E8 ?& L1 t3 plong-run. Since homebuilders build to meet demand, we( T2 i! |8 _, ^/ h q: E
regard housing prices and household formation as the drivers
0 ? [( ?1 X- r, [2 w* ~of residential construction.
# H9 H) n& _5 A7 JTo examine the degree of overbuilding, we employ a ^) F* k2 l' H% ] E ?( c
“counter-factual,” asking what level of residential construction- N) b: B' V' E3 b7 y: F% G1 h
would have occurred if housing had been priced+ b7 @7 B: f4 [* l- {- p
optimally. We find that actual homebuilding exceeded this
8 \; J5 {1 Q( p& Yfundamental-justified level by about 12%. Although new
8 u y8 j6 x1 E# D8 P4 Z+ g uunits were being absorbed, homebuyers simply bought too
& f6 Y! B* w& r |many houses at prices that exceeded fundamentals.
3 r- J3 S/ a) R; tRegionally, we see the greatest strains on the Prairies,$ d, b$ D) [' h) [0 K, ]
where housing demand will further contract under waning E1 J4 Q6 R+ J9 @" ]- i
population inflows. Saskatoon, Calgary and Edmonton are x f! o# k1 m& [4 a; _. r
already witnessing surges in their unsold new homes at the+ K) i: I5 M) o/ {% a
very time that the resale market has swung into strong9 K1 ~5 \4 i- p
buyers’ territory. Homebuilding in the Atlantic provinces
7 \' P+ M' ^3 n: G" Y3 g3 b5 a7 jhas been relatively balanced but, while not plagued by structural& Z3 L9 E( P) J$ f: q7 S4 h
weakness, will be singed by the downturn nonetheless./ |5 q7 @/ X! h' n" w
Québec shows signs of strain – especially given the% K: @. O9 k- D% i4 [
strange accumulation of unabsorbed multiples on l’Île de
1 O1 C" r' T# e% D" N0 {& RMontréal – but recent building has been relatively balanced,0 y# x3 Z. m% q; g3 J0 E# O/ M% @
given the province’s history of under-building and low ownership' Z5 C D5 S8 x, z* b
rates. While Ontario homebuilding will reel from a
0 N: N4 C- g3 N$ y1 vcyclical downturn, the degree of structural weakness appears2 A7 l9 U! _, a/ @5 }9 N# S0 D* g
limited – with the important exception of the Toronto5 h1 ]4 D) U1 V: q$ n
condo market. Both in Toronto and Vancouver, historically6 `4 ?) e' z4 ]; u1 W3 F% Y
high levels of apartment-style units presently under: Q5 u* B: V! z) L" |
construction mean that record numbers of condos will
7 T/ ]' ?/ \6 b$ H1 Ireach completion during 2009. If absorption rates fall, as
3 U5 D! D- _9 \cyclical factors would indicate, condo inventories could
2 ~/ h) F! w+ Z6 G& Hspike severely – particularly in Vancouver. However, while/ {5 s/ ~% W$ @6 w
residential construction in B.C. will definitely droop, we
- \$ O. X& G, n9 {& V6 yanticipate that the West Coast will continue to benefit from
% b. q3 q4 _# y3 hinter-provincial and international migration over the coming
! Y* c* ~7 w9 y" x# C! y7 U. j: Vyears, which, along with improvements in affordability,
# E+ H1 M* {+ o, p, Wwill alleviate some of the pressure from overbuilding.
9 o8 u% j7 W* n6 nOVERPRICED AND OVERBUILT: CANADIAN HOUSING* c* K* m, i- Y+ Q5 [* h7 D
MARKET RETURNS TO FUNDAMENTALS
9 `* r3 G& R) U, i* E+ K# cGrant Bishop, Economist1 P) H9 v) G3 v) d+ m. @+ [
416-982-8063
4 i4 H9 Q6 _7 l- i1 @" pPascal Gauthier, Economist
- `$ K4 A# t y: j416-944-57300 i# l* d) b- ^) _" H% B6 I
; i) `) J1 E" p+ d& L$ thttp://www.td.com/economics/special/gb0409_housing_exec.pdf |
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