TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
6 x8 ]9 v6 b, Y& a# e' m( C' ?from 2002 to 2008, unsustainable price increases drove
unsustainable levels of building. Our view is that house
prices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
6 c- M" R: \# t" U: G4 ?overpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
8 d* M$ I/ G: pthree years.
By “overpricing” we mean that prices detached from
9 v: V+ i4 X9 R" S: ]3 gtheir fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
! Z1 V5 }; U6 @" _. A9 N# |both a cyclical downturn and a return of house prices
- _' O) o* |( Dto fundamentally justified levels.
5 f/ b9 z# a! h# [1 [3 O' k- @We consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
" Y" j, z! x+ a  ^! d. i  F% bthat this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
/ s1 A( a5 ]: m3 \; I: v' Jthere is evidence of both types, we contend that Canada’s
' p  s' ]6 c0 S2 S“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
* u- I, o9 K7 I: V# qWhile most markets won’t face U.S.-style overhangs,
the construction of too many new homes over the boom
means a deepened slump. This overbuilding will likely weigh
on markets over the next few years. Even as Canada recovers
: g4 P) w0 L$ N* G# [3 c& H6 `' Bfrom the cyclical downturn, house price growth will
remain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
; r# Q! I6 {$ {& G. Ais now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
* m4 z1 {( T7 [# ^5 a7 ]. iresidential construction will fall further to around
( r, f! U4 F6 Q125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
To quantify the degree of overpricing and overbuilding,
we first develop an empirical model, based on long-run
fundamentals of house prices and housing starts in each
province. Affordability is the key concept behind home
6 u1 V: r1 }5 F( tvalues since house prices should track incomes over the
8 T1 g- I- y  rlong-run. Since homebuilders build to meet demand, we
regard housing prices and household formation as the drivers
of residential construction.
$ U3 R2 |: e2 l1 ETo examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
9 T& o3 A% i9 p+ f3 G7 Bfundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
/ c' x2 F; G" \, t% G( bmany houses at prices that exceeded fundamentals.
3 {# _- w! X, C# h/ t8 i8 DRegionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
, L- ?' H, Y5 F3 epopulation inflows. Saskatoon, Calgary and Edmonton are
3 P5 M, Q, G7 b9 r' l6 {already witnessing surges in their unsold new homes at the
very time that the resale market has swung into strong
4 o, s7 o+ V" k# r+ x% Fbuyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
weakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
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
' v; c# }3 v4 ^9 {5 J5 gcyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
2 L2 R) V& Q$ K! Bcondo market. Both in Toronto and Vancouver, historically
% d5 S: h+ m2 Z. N4 e) E6 Whigh levels of apartment-style units presently under
construction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
0 D" F- F( ]$ F/ _, `cyclical factors would indicate, condo inventories could
, V/ x8 M. m+ U4 p  ^spike severely – particularly in Vancouver. However, while
residential construction in B.C. will definitely droop, we
+ @5 Y0 {) f% b% b+ Santicipate that the West Coast will continue to benefit from
( S" X* y, ?1 U$ Finter-provincial and international migration over the coming
$ }; R7 X0 j" u% I" G6 w5 a- [' v0 ~years, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
$ e/ b5 R1 ?2 R4 I1 n& k1 BOVERPRICED AND OVERBUILT: CANADIAN HOUSING
9 b. f( h" X- CMARKET RETURNS TO FUNDAMENTALS
7 _# W7 C$ I, ?1 ^6 NGrant Bishop, Economist
: w1 s+ G2 m- w/ E% g416-982-8063
Pascal Gauthier, Economist
4 l* B7 b7 F' W. o3 B6 M* s416-944-5730

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

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