TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
- W& m* s0 e2 L9 O/ ofrom 2002 to 2008, unsustainable price increases drove
unsustainable levels of building. Our view is that house
4 H( h; ]. O3 h0 V0 u) i( P: @! ~prices exceeded the value of housing that was justified by
0 @5 K6 ^' U. C( e( i9 W& u% S( Ffundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
5 {& Q: Y0 i  rthat exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
7 @6 ]5 y, C1 ~2 F. o; Fthree years.
0 U3 f7 [0 h. ]: T/ R3 t% CBy “overpricing” we mean that prices detached from
/ L: ^. k3 t) 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
8 e! D5 V& m( e' y0 W# x0 ~to fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
6 w( C0 b* X+ K6 K, Swhere homebuyers buy up too many houses and
+ n4 X& @) q- F# W6 Vthat this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
6 Y2 L& H# b+ Sthere is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
( X0 M: A  K$ s& Y/ r: c5 ohomebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
9 w9 O0 @$ r! g  t9 c4 B8 W' X) VWhile most markets won’t face U.S.-style overhangs,
+ @* ]5 H, S- S: pthe 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
remain choppy and new residential construction will be
2 Z' l; G% i- h1 ]( ]1 @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
+ C, _4 C, n& a5 Y0 \) w0 q9 i: zresidential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
1 d' t. K  E4 v6 A2 Y; o% M  win the fourth quarter.
To quantify the degree of overpricing and overbuilding,
! n2 q6 j- j1 O  o2 s" ]3 Zwe first develop an empirical model, based on long-run
fundamentals of house prices and housing starts in each
: v+ D0 A# i5 y6 |: _province. Affordability is the key concept behind home
- Y8 ?* F+ H- z: Z5 ^2 x" o* U" Nvalues 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.
. }* N3 d, A/ e$ u) ITo examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
* R" \. T+ X1 P+ \would have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
4 K/ d% w$ n" ^) b, Ifundamental-justified level by about 12%. Although new
units 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
* j3 _6 F; O8 i5 k& D. v) opopulation inflows. Saskatoon, Calgary and Edmonton are
( D! E9 L& L, X2 d9 C- ]" Salready witnessing surges in their unsold new homes at the
very time that the resale market has swung into strong
0 f4 x" L# U/ \, v5 S. S* \buyers’ territory. Homebuilding in the Atlantic provinces
  l7 J2 |* g$ N& vhas been relatively balanced but, while not plagued by structural
; f+ e/ g# Q3 W( k2 l% z# {weakness, will be singed by the downturn nonetheless.
( |4 o2 P' f0 t9 eQuébec shows signs of strain – especially given the
" o$ R6 r7 _( j0 @strange accumulation of unabsorbed multiples on l’Île de
- R) I2 Q1 m" [& h: k" M- W6 sMontréal – 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
- w5 X: v+ z9 B6 Z4 H0 wcyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
condo 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
8 R0 e0 y, ~5 X9 P# q) @1 s$ {" tcyclical factors would indicate, condo inventories could
$ ~, n5 j4 b# p' G5 K# Espike severely – particularly in Vancouver. However, while
residential construction in B.C. will definitely droop, we
9 L, p) a3 u: S7 Y: {; C/ U. Oanticipate that the West Coast will continue to benefit from
inter-provincial and international migration over the coming
years, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
, Y9 Z5 n; R9 B) gOVERPRICED AND OVERBUILT: CANADIAN HOUSING
7 v# I+ S& c4 Z4 L4 L( ~4 `MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
Pascal Gauthier, Economist
416-944-5730

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

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