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
prices exceeded the value of housing that was justified by
- a6 x' Q3 N. [' e. wfundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
6 O, u% ~6 x2 h7 C0 X; t  M; ~4 hthat exceeded its fundamental-justified level by approximately
/ H& }! _: a% y12%, an excess that was exaggerated in the past
5 _# b# {. q- x. ythree years.
By “overpricing” we mean that prices detached from
; A' u; D$ Z) p6 Jtheir 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.
4 p& v6 F( d# p8 XWe consider “overbuilding” of two forms: “demanddriven”
2 A5 _4 b' `0 a) e2 |9 `where homebuyers buy up too many houses and
5 P3 Q- }1 e6 O$ s" q. z, Tthat this demand cannot be sustained; and “supply-driven”
& L: v  P  X4 [3 q% ~  m7 N4 _, }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
  c' x& W; v8 W$ Zthat is now being rapidly reined in.
; b2 ?: N( W- p( O; S4 DWhile most markets won’t face U.S.-style overhangs,
; K& I9 }: [: rthe 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
from the cyclical downturn, house price growth will
8 [  ]# p& Q3 G" ^) g: i0 X0 E9 jremain choppy and new residential construction will be
5 @8 z5 J: |* S- b& ^0 Cdampened, owing to this structural weakness. Construction
" p% Z  s% D. V/ K1 u6 r! Zis now undershooting fundamentals and we expect this
& `* Q) ?0 f0 v7 i$ K. N- \% k# g0 Eto 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
! q7 b0 F; s) e' S4 qin the fourth quarter.
5 B! F6 w8 ]  v# x/ \9 G8 |To quantify the degree of overpricing and overbuilding,
5 l) I( b/ E1 B; x7 }% Z7 C( U; o1 uwe first develop an empirical model, based on long-run
6 ~7 h2 H4 I- }7 W: q4 dfundamentals of house prices and housing starts in each
province. Affordability is the key concept behind home
3 Y. s# }8 s# j4 Q% J( `values since house prices should track incomes over the
; @2 r4 M) ?' \7 i- B4 @long-run. Since homebuilders build to meet demand, we
7 X7 l5 @: r& c, Z7 Y. Pregard housing prices and household formation as the drivers
; R% I0 l1 X. Z6 q* j7 w2 }; Y; Fof residential construction.
) d5 \/ D7 ^2 ?3 Q4 ITo examine the degree of overbuilding, we employ a
/ l, S; P: v$ v1 o“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
, `: ^8 B# Q7 W) R. C+ \optimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
, a0 k* W# y" A( }% h0 `% Hunits were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
' U4 J1 Z% ^* i7 T" m2 D7 Ypopulation inflows. Saskatoon, Calgary and Edmonton are
* a7 ?, n! _# V# O4 O7 p; Ealready 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
has been relatively balanced but, while not plagued by structural
weakness, will be singed by the downturn nonetheless.
% W4 K1 H# n" R4 S9 M2 X- YQuébec shows signs of strain – especially given the
strange accumulation of unabsorbed multiples on l’Île de
. y% R9 U6 e1 |# z: [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
$ ~  Q, D3 ?) X0 p( ]cyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
6 l/ o; s5 Q+ n( f2 Z, i+ Uhigh levels of apartment-style units presently under
! e& W; j4 O& g5 Tconstruction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
8 n; a7 C! C' X4 |0 t+ Scyclical factors would indicate, condo inventories could
2 p$ }. _, h# k: C/ v' kspike severely – particularly in Vancouver. However, while
( g, B# l; a, m& v& Dresidential 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
% K( z/ R" ~; o4 L8 Gyears, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
4 v. Z+ z% V' }) ]OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
, w! j# `1 N) g( [  wGrant Bishop, Economist
) x/ o* }- U! X% x3 R416-982-8063
/ g" C) O3 n* L! y; K, C) lPascal Gauthier, Economist
/ B, G2 y' B, P; ~9 S416-944-5730

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

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