TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
2 z! p  t: |% I7 l( U4 M% b5 `from 2002 to 2008, unsustainable price increases drove
unsustainable levels of building. Our view is that house
9 D$ W  o! x5 n! Q0 bprices exceeded the value of housing that was justified by
' s1 Z3 u5 n  M0 ifundamentals by approximately 9% nationwide. This
- C: `# T. {, L1 i" @2 t$ a+ Ooverpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
( @; E5 y# l. X/ u3 ^three years.
6 x! R$ ]! n3 KBy “overpricing” we mean that prices detached from
' V; j/ G8 o! m4 s% U) a) n* W  btheir fundamentals, as witnessed by a steep erosion of
3 R3 f; t! |$ u& z' D# x) ^9 C1 Maffordability. The current unwinding of house prices reflects
both a cyclical downturn and a return of house prices
: Q& [7 b+ Y1 O0 n% M$ ^to fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
  i0 G: ~1 A  z# c( x8 pwhere homebuyers buy up too many houses and
+ c4 u- E/ Z! @7 J7 U* cthat this demand cannot be sustained; and “supply-driven”
% ~( Y' X, ^% j3 S/ iwhere builders accumulate excessive inventories. Although
# n8 X* ^  I) l- g! U+ o/ ithere is evidence of both types, we contend that Canada’s
5 p; l/ I8 A$ G! ~# g: @“overbuilding” was mainly of the first type, where
* G: J0 P+ a: O* s, H; dhomebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
$ t- X7 ~5 Y* \- T. RWhile most markets won’t face U.S.-style overhangs,
' w  Y& t) f/ B0 o8 cthe construction of too many new homes over the boom
% B3 q- ]2 |1 b* n& D" `3 Kmeans a deepened slump. This overbuilding will likely weigh
  q% Z* _7 J" x! ]- fon markets over the next few years. Even as Canada recovers
from the cyclical downturn, house price growth will
  B  H! @- k' W( z$ K' p. e. i5 Hremain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
. T/ t+ W" ?4 z! n) U& _. j9 Cis now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
residential construction will fall further to around
. E2 S: E2 V5 a5 ~. F) m# G125,000 starts over 2009 with a trough around 115,000 units
4 t( S" `) p9 Q" Bin the fourth quarter.
To quantify the degree of overpricing and overbuilding,
/ k6 k! K3 \& m, H' p" Bwe first develop an empirical model, based on long-run
fundamentals of house prices and housing starts in each
3 E$ ?: {) O# g0 e7 `: `5 Bprovince. Affordability is the key concept behind home
* ]3 A6 X( ]/ Y1 p* N" svalues since house prices should track incomes over the
3 x, _+ A9 }/ R5 z5 {6 b/ e4 }3 q! Along-run. Since homebuilders build to meet demand, we
% }. Q1 F; p0 [  w/ H$ eregard housing prices and household formation as the drivers
  F& g4 H$ K. `* E& }7 Zof residential construction.
- L7 W" D$ T/ f' `5 U5 lTo examine the degree of overbuilding, we employ a
& o4 b2 P+ l2 ^0 @; I, m“counter-factual,” asking what level of residential construction
8 O! m1 p5 F$ f1 C( C: E: c, ywould have occurred if housing had been priced
& r% m& L( t+ q. y4 h2 {optimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
4 ?" Q" f. M6 Y! e, M  Tunits were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
% o7 t- N1 G% y3 tRegionally, we see the greatest strains on the Prairies,
" O; L7 t+ h" @! P$ k- D+ g# iwhere housing demand will further contract under waning
- f! V$ X3 O* e! F3 W1 n  X* Apopulation inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
9 W& |' t: c& O& F4 L3 ?( Kvery time that the resale market has swung into strong
% d3 R0 {- T6 e4 n1 @& r1 Dbuyers’ 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
* {$ J& j% A* m. T( FMontréal – but recent building has been relatively balanced,
* q7 A# @5 e; w: t; n7 {% Dgiven the province’s history of under-building and low ownership
1 L* a* G6 D, L! c8 Grates. While Ontario homebuilding will reel from a
( h) i/ c; e. H, Dcyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
  L; r# t" `. J8 s8 R# I+ Ccondo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
construction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
spike 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
8 h" a2 `( V% ?, C, }: q' Wyears, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
6 h3 w8 u: @5 kMARKET RETURNS TO FUNDAMENTALS
' v- ?4 g; [" H2 M7 SGrant Bishop, Economist
) W6 S. N8 J$ @: d/ e7 c. b416-982-8063
* g/ [: z3 f7 D$ YPascal Gauthier, Economist
416-944-5730
6 c2 c9 M  q% e( R: V  z
/ h5 u6 ?1 X- P, `7 q5 ^+ Y3 \3 `http://www.td.com/economics/special/gb0409_housing_exec.pdf

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