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
& [* A- x- D  E9 dunsustainable levels of building. Our view is that house
prices exceeded the value of housing that was justified by
" B0 S5 A9 p$ ?% g: {/ `9 |+ Ufundamentals by approximately 9% nationwide. This
* c2 N0 Q9 [( \$ I$ m  Q& Noverpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
. Y3 i+ i: d6 |  h6 P) V! V12%, an excess that was exaggerated in the past
three years.
By “overpricing” we mean that prices detached from
% s/ l+ e- R$ ?0 Z( Z& X. btheir fundamentals, as witnessed by a steep erosion of
4 o7 J0 V/ Q" R; |: Faffordability. The current unwinding of house prices reflects
, V( d8 r8 d* A% H" D( R& e/ bboth a cyclical downturn and a return of house prices
7 G% S6 `! q. k5 m' r9 qto fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
; y8 H4 U2 }4 ?6 A/ h+ Q: owhere homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
+ G8 }3 }1 X  |; C. E) Hthere is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
% I# t# x7 z! @! nhomebuyers pushed homebuilding to an unsustainable pitch
* C! X4 N: H. `2 ithat is now being rapidly reined in.
. l- c; U! }( {2 C( @4 jWhile most markets won’t face U.S.-style overhangs,
the construction of too many new homes over the boom
means a deepened slump. This overbuilding will likely weigh
, o) ?1 {  s8 {  I* c6 `on markets over the next few years. Even as Canada recovers
+ ^4 Y1 w; l% D9 J# ?0 u+ C, pfrom the cyclical downturn, house price growth will
remain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
1 G$ I% N% d% N: `! Ris now undershooting fundamentals and we expect this
6 i' @5 K4 T" G+ p$ [) @7 k# Dto persist over 2009 to 2011. We anticipate that nationwide
residential construction will fall further to around
! h" W2 j' A0 }% `1 R4 f/ e5 W0 V125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
) X6 ]0 X# d" y: j5 f; f( ITo quantify the degree of overpricing and overbuilding,
we first develop an empirical model, based on long-run
9 \! W, P# M& n6 f" M( U0 Vfundamentals of house prices and housing starts in each
province. Affordability is the key concept behind home
% x3 x1 n; c7 m- 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
of residential construction.
+ v+ Z) O! K# s. k: P) DTo examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
* o; d3 u8 n2 N/ \7 s& Fwould have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
; f  n+ E6 Q0 m' w# h4 Nfundamental-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,
' ]. y8 y9 Y5 S4 I0 m8 ?* |3 Wwhere housing demand will further contract under waning
% H: E* k. a- U4 B0 J7 `population inflows. Saskatoon, Calgary and Edmonton are
4 s2 [6 k) ?! I; Calready witnessing surges in their unsold new homes at the
very time that the resale market has swung into strong
* v9 r  Z; o+ R  dbuyers’ territory. Homebuilding in the Atlantic provinces
3 a+ Y* C% j. b; n  A. fhas 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
2 e3 B6 n* @8 M* f4 K& |" W( e2 fstrange accumulation of unabsorbed multiples on l’Île de
, N2 q9 ^+ t6 A) [( y/ w/ RMontréal – but recent building has been relatively balanced,
$ `' l. I0 Q8 j7 wgiven the province’s history of under-building and low ownership
' h) @" N/ f9 W3 d4 }3 N* e4 Erates. While Ontario homebuilding will reel from a
. D0 [6 [6 ~+ J5 H% b! scyclical downturn, the degree of structural weakness appears
: c% ~5 [& e2 H2 w# O' alimited – with the important exception of the Toronto
* m# P/ |# C" p% R) ncondo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
  }% b$ p5 ?9 t4 v* Aconstruction mean that record numbers of condos will
8 A6 z$ }1 j* S7 B+ E: Preach 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
: M1 k* W; X8 o) n2 Z: E& eyears, which, along with improvements in affordability,
% \- A3 L$ f) jwill alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
- k: R8 G$ P& M7 x1 U" u+ g416-982-8063
! R+ p* {, z9 `& B: fPascal Gauthier, Economist
416-944-5730

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

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