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
) c7 L% j  \" o6 nunsustainable levels of building. Our view is that house
6 n$ H8 Y( n. _9 Oprices exceeded the value of housing that was justified by
6 Y1 P, _5 G9 J5 h* G$ Vfundamentals by approximately 9% nationwide. This
' v+ [3 V1 r3 Goverpricing compelled a level of residential construction
! p7 ?3 }2 ?1 Othat exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
0 Q3 n2 G' h* e  W6 `( Y# qthree years.
& |. N' Y+ s3 L) n0 i; i' VBy “overpricing” we mean that prices detached from
$ j% j9 z8 E; C+ \# Z( Wtheir fundamentals, as witnessed by a steep erosion of
8 X+ U0 M4 q$ f# i& z* n/ M" V, ?# M" @affordability. The current unwinding of house prices reflects
9 v; u1 Y$ ~, h8 uboth a cyclical downturn and a return of house prices
: a1 G" {# s$ b; Zto 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”
+ [/ x3 E7 ^. a8 }, ?( _where builders accumulate excessive inventories. Although
1 q6 ]% |  P" ~; vthere is evidence of both types, we contend that Canada’s
$ X3 R# d8 ]3 l' `“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
2 i/ T* o; v7 R7 T3 q# @7 hWhile most markets won’t face U.S.-style overhangs,
, p1 U$ M, ~1 c9 g- rthe construction of too many new homes over the boom
means a deepened slump. This overbuilding will likely weigh
4 d/ Z: \! K8 z) ?  {on markets over the next few years. Even as Canada recovers
from the cyclical downturn, house price growth will
' l" N; e, k) d* Xremain choppy and new residential construction will be
! W4 f# ^$ T3 Z; h! T7 Q( sdampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
1 W5 W# m4 q% k- v( ito 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.
To quantify the degree of overpricing and overbuilding,
we first develop an empirical model, based on long-run
9 `  \* S" w# @1 _. {" B' k, ?fundamentals of house prices and housing starts in each
province. Affordability is the key concept behind home
7 W, i% q" M* U& V# [values since house prices should track incomes over the
1 G% F  x4 e# ]5 y! Z5 k, y0 ylong-run. Since homebuilders build to meet demand, we
) r' ]: g# Y/ V% S+ qregard housing prices and household formation as the drivers
of residential construction.
4 p" y/ s1 K- `0 d7 D/ NTo examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
7 c* j0 d, V1 @( U: z: z, nwould have occurred if housing had been priced
: y* _1 A3 s( R. F; Soptimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
& T6 \+ o! X3 Q. E5 |many houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
3 m1 E7 i0 X" Z0 {5 {# kalready 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
1 z: s4 e+ ^9 e" }3 l* S5 Lhas been relatively balanced but, while not plagued by structural
0 S) b; @/ t8 X* i) G: @0 |. `weakness, will be singed by the downturn nonetheless.
4 U  A' J# o6 EQuébec shows signs of strain – especially given the
( ^" R$ N3 _7 s( s  sstrange accumulation of unabsorbed multiples on l’Île de
5 j; [# B3 I; ?+ _* r) j" ], x& ZMontréal – 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
cyclical downturn, the degree of structural weakness appears
, I! x& Y) ~7 r8 M7 x& ]limited – with the important exception of the Toronto
2 [* k0 _6 |* Pcondo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
construction mean that record numbers of condos will
. `* x) X6 Y7 l) hreach completion during 2009. If absorption rates fall, as
7 @' ^  o: U6 S( A: }7 c# a- _$ N, Vcyclical factors would indicate, condo inventories could
! _2 O$ y8 e# K/ m$ n# e% espike severely – particularly in Vancouver. However, while
residential construction in B.C. will definitely droop, we
4 l) j3 r" ?: U: yanticipate that the West Coast will continue to benefit from
inter-provincial and international migration over the coming
* V" h/ K+ R2 t. W1 U+ L4 Cyears, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
2 ?8 S, T5 g  ?: T  `( _" `OVERPRICED AND OVERBUILT: CANADIAN HOUSING
/ B. k9 N  f) Y. e5 A$ @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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