TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
from 2002 to 2008, unsustainable price increases drove
unsustainable levels of building. Our view is that house
/ C1 E6 c, G' Q; w# _  @  Sprices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
three years.
: r. m% Z4 w& m) GBy “overpricing” we mean that prices detached from
$ z: c6 F8 d1 x; A& Q3 e" G) \: y$ Ktheir fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
; E0 }/ X$ m+ M* U! d0 Aboth a cyclical downturn and a return of house prices
' M! J8 w% ]4 d( |/ z% q" [  Gto fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
  B  h4 K( V. F1 O# Athat this demand cannot be sustained; and “supply-driven”
/ F4 t- ~! a. lwhere builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
* |3 J! `( [+ q" f2 x% j. ?/ B' }* K: M“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
9 m* a& z7 ^* |6 xthat is now being rapidly reined in.
# H5 x1 `- |4 X+ n+ b, k$ UWhile most markets won’t face U.S.-style overhangs,
/ y" I9 Y7 b  N3 r" j' r$ Ethe 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
  w& W& b; v4 ]: Y/ Hfrom the cyclical downturn, house price growth will
remain choppy and new residential construction will be
: f; Q! P/ J6 D3 ^* ^% X1 ]) K) gdampened, owing to this structural weakness. Construction
+ N: u+ W# Y1 x0 bis now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
residential construction will fall further to around
' k; i; M- E! G2 Y125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
$ t; @9 L$ ?. ~1 |$ Z9 WTo 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
8 o) `9 `1 p9 M& Wlong-run. Since homebuilders build to meet demand, we
% }6 z# d  a8 O2 k. ?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
optimally. We find that actual homebuilding exceeded this
! f! @9 T4 ^9 z% p! R& Gfundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
/ b: d4 q! B9 i- A8 ymany houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
) e6 ?" L. T$ d; a5 Kwhere housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
  u4 j% C2 M$ l# X6 Fvery time that the resale market has swung into strong
. Y3 o: G/ P# K* m7 U( [; D' _: P# dbuyers’ territory. Homebuilding in the Atlantic provinces
2 Q; K0 N* g# s% l8 L; |; Xhas been relatively balanced but, while not plagued by structural
+ J  w7 R7 X/ p, Z4 p6 zweakness, will be singed by the downturn nonetheless.
0 D% Q- U. Y. {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
$ X' W7 h/ X; c" I/ g: B) wrates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
, E# s5 i, Z+ f7 _) }2 Hhigh levels of apartment-style units presently under
7 L4 |4 C3 h' a& w4 k4 ^( Wconstruction mean that record numbers of condos will
7 w6 A+ n* q2 W* g* kreach completion during 2009. If absorption rates fall, as
/ N. o# R% ]5 w  Bcyclical factors would indicate, condo inventories could
( _$ s1 D6 o# ]) N$ K$ H% _& 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
inter-provincial and international migration over the coming
* E/ n/ q. m& t3 O0 `8 s1 V2 Byears, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
: U8 L0 `9 V2 p- kGrant Bishop, Economist
416-982-8063
! s3 H  A" @# rPascal Gauthier, Economist
416-944-5730

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

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