TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
) o2 y; B* J) l. z. s4 j1 Efrom 2002 to 2008, unsustainable price increases drove
- O) p# r& h+ k8 H! yunsustainable levels of building. Our view is that house
prices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
  Z% Z( e  z0 g* ~overpricing compelled a level of residential construction
# t, U; C: R/ vthat exceeded its fundamental-justified level by approximately
+ g/ B7 X. u! x, s3 V12%, an excess that was exaggerated in the past
three 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
both a cyclical downturn and a return of house prices
to fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
- ~& X$ h8 E! \5 cwhere builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
6 w2 H, @7 l! T# C) u, A% s“overbuilding” was mainly of the first type, where
# V$ h/ {- y/ I9 R8 shomebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
  }3 x8 s3 m) O! F7 uWhile most markets won’t face U.S.-style overhangs,
3 X% d* s' V1 H4 Othe construction of too many new homes over the boom
means a deepened slump. This overbuilding will likely weigh
  \9 s6 b! ~0 e9 ton markets over the next few years. Even as Canada recovers
from the cyclical downturn, house price growth will
; g8 H/ p  j) t. F$ ]0 y% @, fremain choppy and new residential construction will be
' Q! c% M' {: x1 S9 `! a" L* @dampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
0 r: A+ n1 d& ^$ {' Vresidential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
/ ~( J6 P3 k: aTo quantify the degree of overpricing and overbuilding,
we first develop an empirical model, based on long-run
# d8 v+ M- D, |' f( s4 ?& e2 O9 Lfundamentals of house prices and housing starts in each
province. Affordability is the key concept behind home
3 d* N# D6 L5 Y3 @* Wvalues 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
/ g3 b6 }, C4 f9 `2 ~9 F: I  Bof residential construction.
+ J" D. M0 y0 b. u6 FTo examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
9 Y& u( E1 c7 {3 ~+ Ywould have occurred if housing had been priced
' U1 q9 ^! c$ H4 D- p' j6 w5 ?optimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
9 }1 o, L0 V& Z4 c' ]units were being absorbed, homebuyers simply bought too
( y/ M" L& K5 q+ P& n% Rmany houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
7 O) B2 {3 I) J* Q+ xpopulation inflows. Saskatoon, Calgary and Edmonton are
6 o5 V2 a; o1 i3 Qalready 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
3 {+ q9 k* A  U! ahas been relatively balanced but, while not plagued by structural
weakness, will be singed by the downturn nonetheless.
3 a0 ?6 g/ H. dQuébec shows signs of strain – especially given the
% T% k+ J- p! M1 e, f0 wstrange accumulation of unabsorbed multiples on l’Île de
/ A' |, l9 K1 Z, M$ A/ G/ jMontréal – but recent building has been relatively balanced,
# ^4 r# N! V; k) _given the province’s history of under-building and low ownership
rates. While Ontario homebuilding will reel from a
/ g2 @0 X% S2 Y6 \7 N' `cyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
0 t+ L# z- s; Ncondo market. Both in Toronto and Vancouver, historically
, n# L6 ]; r; P! y$ Q6 n! Shigh levels of apartment-style units presently under
& v+ g3 L" x2 m6 yconstruction mean that record numbers of condos will
; n0 }! ^7 ]4 K  |! W6 k4 V; Rreach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
( \2 t: j( N3 s0 H4 ^+ e6 s% V& z! _spike severely – particularly in Vancouver. However, while
- y5 B* g" k$ G/ W3 k& hresidential 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
years, which, along with improvements in affordability,
/ M5 w. T7 A7 {5 d8 Swill alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
# }; @% K3 L8 @% P$ G. N' hMARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
% i3 s" x3 h+ D0 y' l* ]Pascal Gauthier, Economist
416-944-5730

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

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