TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
  Z4 F) V# ?  E" ifrom 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
fundamentals by approximately 9% nationwide. This
# X/ J  \3 P7 U% J9 q" `5 l- t( Foverpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
& G$ O" W+ B) ^( M$ Y7 O" e12%, an excess that was exaggerated in the past
three years.
8 D/ z. j' G/ z# I5 u& L1 {, eBy “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
( }7 |5 f( {5 I( J5 R! oboth a cyclical downturn and a return of house prices
- |- H& \+ g3 E+ Hto fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
$ w- ?; `' ]% Z/ pwhere homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
# y! \6 j# v* r( vthere is evidence of both types, we contend that Canada’s
* v) i1 j0 M5 a8 M9 K; O& m“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
0 f2 @' S( d) U* [* ~/ `/ mthat is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
4 [$ k2 T" o2 Nthe construction of too many new homes over the boom
means a deepened slump. This overbuilding will likely weigh
1 C& c/ E# _9 @! r9 b. n5 Y4 don markets over the next few years. Even as Canada recovers
0 r& K# F/ o* Y% ^) ^from the cyclical downturn, house price growth will
remain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
- f9 H  u& T+ U: x  J+ |. y1 Pis now undershooting fundamentals and we expect this
* y8 z4 K- C2 A! X6 m9 Zto persist over 2009 to 2011. We anticipate that nationwide
6 Q/ `; O5 W) f% }. eresidential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
) I) N+ P) s* E0 l% FTo quantify the degree of overpricing and overbuilding,
we first develop an empirical model, based on long-run
0 I( h: t' P4 |7 O, x1 ^* Y; Sfundamentals of house prices and housing starts in each
. k6 ~& d' R5 x0 e4 [3 dprovince. Affordability is the key concept behind home
2 P$ Y# u* p) ]4 b0 n) @6 bvalues since house prices should track incomes over the
3 e, K$ t$ c7 Y) glong-run. Since homebuilders build to meet demand, we
' T% B5 h  P) x- G( `# i. n: B8 J2 wregard housing prices and household formation as the drivers
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
: X5 O7 W) w5 ]$ Y  T1 `optimally. We find that actual homebuilding exceeded this
6 K. ]% I; ~2 \  L1 E( }; M1 L6 Sfundamental-justified level by about 12%. Although new
% V9 C' V( I) c! Yunits were being absorbed, homebuyers simply bought too
2 {( V+ O" A4 Z- J: A" kmany houses at prices that exceeded fundamentals.
9 Y! y0 z' j9 Q7 }Regionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
* O$ M6 R3 b1 k2 F/ v  A  \population inflows. Saskatoon, Calgary and Edmonton are
5 |) F0 d! e. G! m6 N  C7 c# aalready 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.
4 X7 M, c  _/ i9 C, i0 G2 u7 g) FQuébec shows signs of strain – especially given the
' _4 A8 ]+ P% C7 Kstrange accumulation of unabsorbed multiples on l’Île de
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
. j) m/ O2 Z0 N) @9 ^cyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
9 z+ ^/ M! Y9 G4 m1 q8 d# hhigh levels of apartment-style units presently under
8 J* v+ Y2 R5 U* x' q* p3 ^construction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
" l( D8 }# l; Fcyclical factors would indicate, condo inventories could
8 H" P) y6 L0 qspike severely – particularly in Vancouver. However, while
1 g; Y0 j" u( S: \9 ]residential construction in B.C. will definitely droop, we
anticipate that the West Coast will continue to benefit from
( y+ Y4 _2 j5 h) p  l' e) `- ^' K0 Vinter-provincial and international migration over the coming
years, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
( k8 X2 Z( m, F! c- R; O( gGrant 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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