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
unsustainable levels of building. Our view is that house
prices exceeded the value of housing that was justified by
) ]. [, {3 Y* Ifundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
) m0 T$ ]' |5 L" p6 L* `12%, an excess that was exaggerated in the past
$ }  {' J" Z9 p% A$ Pthree years.
By “overpricing” we mean that prices detached from
$ ~0 t& J$ s3 C9 ptheir fundamentals, as witnessed by a steep erosion of
& }. h- x; z0 c  _affordability. The current unwinding of house prices reflects
both a cyclical downturn and a return of house prices
" T6 [" h& d. K" @8 x) \! X0 ^4 Y+ Ato fundamentally justified levels.
+ Y% t9 Z1 X8 y1 c  y! y3 B, H5 w! lWe consider “overbuilding” of two forms: “demanddriven”
! G! C2 \7 N, |& mwhere homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
+ k" @- `& M# H( a$ l* n$ ^# Lwhere builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
7 D$ Y$ O# y' i. D6 s5 }2 I“overbuilding” was mainly of the first type, where
& `: a0 ^: M. {9 R. @5 I! Bhomebuyers pushed homebuilding to an unsustainable pitch
, K" D" _/ T. ?$ _* J& ^that is now being rapidly reined in.
+ F; G& G! _! C% w- sWhile 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
4 v9 o5 O' c6 {" i. Z8 M8 _$ bon markets over the next few years. Even as Canada recovers
from the cyclical downturn, house price growth will
! R! u' N. `6 w' d/ [8 Eremain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
6 O7 r3 ]0 a) Z; x' J- xto persist over 2009 to 2011. We anticipate that nationwide
residential construction will fall further to around
3 a. r% ~+ I' B8 v125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
* l; v* ?- M1 N+ ^4 v2 N6 WTo quantify the degree of overpricing and overbuilding,
we first develop an empirical model, based on long-run
fundamentals of house prices and housing starts in each
province. Affordability is the key concept behind home
. g- L/ X4 l2 {3 Y; }- k& svalues since house prices should track incomes over the
( y& L# `8 [6 C9 S" o7 Plong-run. Since homebuilders build to meet demand, we
regard housing prices and household formation as the drivers
/ u8 P+ Q  p4 V9 R" J7 d& Fof residential construction.
To examine the degree of overbuilding, we employ a
9 C& H1 I7 _1 a. A, R“counter-factual,” asking what level of residential construction
, b9 @* k( _7 Awould have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
& g7 f0 {4 O$ W  pfundamental-justified level by about 12%. Although new
6 d8 S6 I( h6 `* L4 r. g- punits were being absorbed, homebuyers simply bought too
! o7 `, O7 @" n4 Y9 Q8 A7 Wmany houses at prices that exceeded fundamentals.
, b; W! C, b/ sRegionally, we see the greatest strains on the Prairies,
7 s$ J1 t- f3 D5 }6 Owhere housing demand will further contract under waning
/ |$ c* ]$ j( d* t9 y2 spopulation inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
, a+ D  g9 x# [, |very time that the resale market has swung into strong
3 D  k* h  k- e2 v9 M; n4 ybuyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
weakness, will be singed by the downturn nonetheless.
5 ~9 e  `7 i7 E% UQuébec shows signs of strain – especially given the
strange accumulation of unabsorbed multiples on l’Île de
4 V/ U0 E! b5 {2 q( E: }2 lMontréal – but recent building has been relatively balanced,
* U+ W! z$ _4 C8 l& zgiven the province’s history of under-building and low ownership
( o0 R5 E6 l6 k8 [' S9 Brates. While Ontario homebuilding will reel from a
3 b9 I; e! |4 m" K4 V; m6 Scyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
$ V& C4 l* l, z+ }, m6 f3 R/ Dhigh levels of apartment-style units presently under
+ B( ^, e7 o5 }1 ?( i# `construction mean that record numbers of condos will
% \# d2 d' w; M1 w1 ]1 t, Greach completion during 2009. If absorption rates fall, as
, b" O% A% s7 [' {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
2 V# A& I6 H+ t- w: D) yinter-provincial and international migration over the coming
( w  k7 e3 \& h8 p2 Oyears, which, along with improvements in affordability,
3 f( m% o: g" @( p) F0 Vwill alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
# p5 F; c( L8 h' Z2 P+ I  {Pascal Gauthier, Economist
9 W2 Q; k! X" v; Q1 L: L1 u6 T416-944-5730

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

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