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
( v6 X; H& S4 ]  xunsustainable levels of building. Our view is that house
prices exceeded the value of housing that was justified by
& Z# U6 a4 X3 Zfundamentals by approximately 9% nationwide. This
3 x& S1 Y- u& `$ H; {# E: `0 eoverpricing compelled a level of residential construction
. `! W# N: H8 g5 K. [+ ithat exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
$ T& M% ]4 B9 J( `" @three years.
By “overpricing” we mean that prices detached from
$ h7 A6 @9 a3 H3 d4 Gtheir 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
' }, E3 ]$ Z$ z6 v) t* @/ k+ Gto fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
/ \6 B5 b6 G! }9 Rthat this demand cannot be sustained; and “supply-driven”
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
6 `4 r, D/ U2 k; athat is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
: V& d1 _, t9 a, ^$ D3 L: lthe construction of too many new homes over the boom
means a deepened slump. This overbuilding will likely weigh
4 Q" Q) l# }  A( n  y4 B0 f! von 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
) C2 C' c) y' s  f) U( K- p) ldampened, owing to this structural weakness. Construction
2 q5 o, ~: {% R& 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
125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
, `. m; D8 s* V. b4 D- x/ cTo quantify the degree of overpricing and overbuilding,
we first develop an empirical model, based on long-run
5 w4 \4 r- `0 C( ?fundamentals of house prices and housing starts in each
0 {, @, H" H) T# b& \province. Affordability is the key concept behind home
# x3 \" }  [1 y4 ^. uvalues 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
9 q* }& ?7 z! l. z: ?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
: w& U0 ^( ?, Z* A4 w! ffundamental-justified level by about 12%. Although new
* L- H$ R0 Z3 Bunits were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
( d& o& `7 v" g" x7 }Regionally, we see the greatest strains on the Prairies,
8 w9 L2 b% \# \* ?3 Hwhere housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
1 s* o6 ~6 x% N9 G* _- Valready witnessing surges in their unsold new homes at the
0 ~# k3 |$ z8 yvery time that the resale market has swung into strong
. k! P1 B. L/ Q0 V' Tbuyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
: s6 O8 f! [8 }, xweakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
/ J0 M, F% ?& q  r# `' cstrange accumulation of unabsorbed multiples on l’Île de
7 f+ p  k- U* F" k, t  hMontréal – but recent building has been relatively balanced,
+ C6 U* `4 l: t  E. ^, a1 P4 Pgiven the province’s history of under-building and low ownership
3 U9 I9 M; R! c3 O; b9 u! erates. While Ontario homebuilding will reel from a
% l& Y6 F: i% i* X3 n! ocyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
2 Q' N) n6 b8 T8 n. @high levels of apartment-style units presently under
6 g2 K& d- E  y2 ?- \* b; Sconstruction mean that record numbers of condos will
1 y" ^. f; Y, p: `$ B1 hreach completion during 2009. If absorption rates fall, as
7 H& t- u4 |' S( i7 h( W8 qcyclical factors would indicate, condo inventories could
) R; Y+ A" J: }& B; O% N  \spike severely – particularly in Vancouver. However, while
residential construction in B.C. will definitely droop, we
# O% Z' J, r# H; ~/ Banticipate that the West Coast will continue to benefit from
inter-provincial and international migration over the coming
0 p% D0 l7 h% E( p# f' ~! vyears, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
- j+ O1 Z/ m- t5 O$ _MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
+ C) c7 i( U# L8 X416-982-8063
Pascal Gauthier, Economist
416-944-5730
6 H9 Q5 T$ j, X: n
http://www.td.com/economics/special/gb0409_housing_exec.pdf

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