TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
  Z9 M+ |- V1 a) |% dfrom 2002 to 2008, unsustainable price increases drove
unsustainable levels of building. Our view is that house
6 G* w( p# m7 @6 I; Y6 l% L& C8 ~, |prices exceeded the value of housing that was justified by
# d$ h2 w0 Z. @# j+ K. pfundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
) S* y8 a# x) `  W- Othat exceeded its fundamental-justified level by approximately
, v+ ]' r/ g& X5 e12%, an excess that was exaggerated in the past
" d; u, v* O* hthree years.
- P# ^. N" b+ V# pBy “overpricing” we mean that prices detached from
+ E& k7 X: Z( ^% ~their fundamentals, as witnessed by a steep erosion of
; p+ ?& Q0 O' \$ l1 laffordability. The current unwinding of house prices reflects
5 W# b7 H: D; K4 L$ K) G5 Iboth a cyclical downturn and a return of house prices
" Q0 E; _/ W" b( f+ i2 qto fundamentally justified levels.
" k  M: x4 w. u* r/ j! F/ @' EWe consider “overbuilding” of two forms: “demanddriven”
" s# _: Q! P, O1 C7 dwhere homebuyers buy up too many houses and
/ f  ~' H3 e5 c, f: `* |/ }that this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
! @" T' ^3 D% J' {0 N3 IWhile most markets won’t face U.S.-style overhangs,
: M1 e! K1 d, K& ^* M( ?2 dthe construction of too many new homes over the boom
means a deepened slump. This overbuilding will likely weigh
$ X8 {/ [5 r0 R$ n$ ?( jon markets over the next few years. Even as Canada recovers
from the cyclical downturn, house price growth will
5 q  m" X4 E# W9 e1 gremain choppy and new residential construction will be
) H0 U( ~/ i3 d+ b0 E9 f; T! jdampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
residential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
  C/ |$ b5 Q3 _( H  GTo quantify the degree of overpricing and overbuilding,
# e7 c! O: }. {3 jwe first develop an empirical model, based on long-run
( A% v1 v! e+ P" afundamentals of house prices and housing starts in each
province. Affordability is the key concept behind home
# q( v0 R- ^( B, y! D5 W) P* d! Cvalues since house prices should track incomes over the
9 ?6 N# m+ u0 m$ w' |$ blong-run. Since homebuilders build to meet demand, we
regard housing prices and household formation as the drivers
of residential construction.
To examine the degree of overbuilding, we employ a
& v% s0 d9 l; F) i3 Y# Z) J“counter-factual,” asking what level of residential construction
) o* H- B* J" P6 R0 P' J+ M; xwould have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
6 B$ q4 N, t) K4 N( x* }- _  hfundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
: y# @# U6 ]2 }9 N/ w3 V/ ]9 o9 omany houses at prices that exceeded fundamentals.
+ w# Y: ?1 q: d0 j' uRegionally, we see the greatest strains on the Prairies,
# Y1 O) @( j, @6 y* j# bwhere housing demand will further contract under waning
0 ?' q5 }7 t8 Y1 J5 [population inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
very time that the resale market has swung into strong
buyers’ territory. Homebuilding in the Atlantic provinces
& m4 {# i) v+ l$ z9 Q+ j9 A( Uhas been relatively balanced but, while not plagued by structural
4 V8 S' s; g; W% h$ Oweakness, will be singed by the downturn nonetheless.
) p: c+ {4 k/ H# E. E0 V! VQuébec shows signs of strain – especially given the
; p; h. c+ b6 N& @! [strange accumulation of unabsorbed multiples on l’Île de
Montréal – but recent building has been relatively balanced,
given the province’s history of under-building and low ownership
rates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
2 ?: S7 T* B* h( O! t5 Vlimited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
% \& \5 W3 O, ^high levels of apartment-style units presently under
. {, k/ @% }' F2 N* gconstruction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
( r! j+ B% L, x; Y% v: ccyclical factors would indicate, condo inventories could
+ a  r1 X6 m6 o8 {spike severely – particularly in Vancouver. However, while
/ f% o; x* z  X' }residential construction in B.C. will definitely droop, we
anticipate that the West Coast will continue to benefit from
, r' G( C$ d# [; Q) P4 P; }* E; Finter-provincial and international migration over the coming
years, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
$ T$ S% h3 d( [5 POVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
$ _# R1 R4 M! J416-982-8063
) c' `0 k2 n. t8 `- KPascal Gauthier, Economist
416-944-5730

http://www.td.com/economics/special/gb0409_housing_exec.pdf

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