TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
2 }" I( d1 W( J7 d/ K1 h! F) jfrom 2002 to 2008, unsustainable price increases drove
) W  Y4 w- Q) Aunsustainable levels of building. Our view is that house
4 M) k8 H! @3 a- G5 Y- M/ zprices exceeded the value of housing that was justified by
6 p1 m) q& \. G3 Wfundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
: L4 U5 B9 T: \12%, an excess that was exaggerated in the past
: O' M4 A7 c2 Hthree years.
By “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
' W/ s  o9 |6 }2 ?  [/ oboth a cyclical downturn and a return of house prices
to fundamentally justified levels.
3 `3 z' F- }% f4 |' {. OWe consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
( n5 J; i0 Z9 {, w! rthat 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
0 S1 F, J/ H+ d1 N“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
# @7 q4 Z% n# j" TWhile 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
" E. v" w5 T2 I" M* x# `9 Yon markets over the next few years. Even as Canada recovers
) N' u7 Q- u/ k3 x9 a% Yfrom the cyclical downturn, house price growth will
remain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
) N+ m1 m% g* `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
; R% @  j3 Q$ L& ?( Y' ain the fourth quarter.
& Q$ ]0 j( I  O; T# b5 t( jTo 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
values since house prices should track incomes over the
long-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
“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
0 q" `( a. q& b9 A# M3 W4 Goptimally. We find that actual homebuilding exceeded this
4 G* ?! Y6 A: jfundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
  G0 s: N* P3 G- }) V; y1 wRegionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
+ S+ p7 H* @7 y4 y# k  V& ?very time that the resale market has swung into strong
buyers’ territory. Homebuilding in the Atlantic provinces
# @9 J) a1 S- ?) _# s6 w7 |% J1 khas been relatively balanced but, while not plagued by structural
9 u( @3 R  I' @0 Hweakness, will be singed by the downturn nonetheless.
- K% f5 I6 d6 [3 r, zQuébec shows signs of strain – especially given the
strange accumulation of unabsorbed multiples on l’Île de
+ ~( c/ n( W3 O, r. PMontréal – but recent building has been relatively balanced,
' w+ i; k6 [1 }+ L9 lgiven 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
6 o* ]0 n: x) ?$ O8 dlimited – with the important exception of the Toronto
7 O* b2 B6 W: Q( M& G& o/ E- [condo market. Both in Toronto and Vancouver, historically
0 v) y0 F) Q, F" Vhigh levels of apartment-style units presently under
; a9 |! u) f5 t& R* a6 Tconstruction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
2 H8 b* x4 E) [. h! k. v) gspike severely – particularly in Vancouver. However, while
residential construction in B.C. will definitely droop, we
anticipate that the West Coast will continue to benefit from
# O. H, n$ v; ^inter-provincial and international migration over the coming
years, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
0 T4 x' z3 q; R2 R8 DOVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
' Q- D6 o& \) h% cPascal Gauthier, Economist
- u4 X/ G% e! A. f* g! e( a0 |416-944-5730

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

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