TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
: v: q# K$ T4 g$ x' x) xfrom 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
" D& y& S: z* E- {, W! P& i/ W& E+ tfundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
5 z3 `6 _* ?2 ]- `* Z% W5 ^12%, an excess that was exaggerated in the past
three years.
" c. u$ q% Y+ U! v0 |! y4 z. ?By “overpricing” we mean that prices detached from
their 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
; ?' h$ t# v. A- q( ?4 Eto fundamentally justified levels.
5 R' v/ S7 T) bWe consider “overbuilding” of two forms: “demanddriven”
% o7 G6 H  i0 K" v1 Y& twhere homebuyers buy up too many houses and
that 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
; z. z- j/ p- E6 J/ c; d“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
, l  i( f) N2 ^While 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
; F" G. ]% c5 I* }- L% eon markets over the next few years. Even as Canada recovers
from the cyclical downturn, house price growth will
; |6 q) o" G& b: S& Q1 _; i* hremain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
& O: x4 Z# X% ^is now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
" P; j* A# C; _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
fundamentals of house prices and housing starts in each
province. Affordability is the key concept behind home
values since house prices should track incomes over the
+ A* K2 |- _8 Vlong-run. Since homebuilders build to meet demand, we
regard housing prices and household formation as the drivers
of residential construction.
To examine the degree of overbuilding, we employ a
+ {: \7 Z1 j+ q9 i% w- |8 ?“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
$ K$ S: i$ S6 a) f% f5 aunits were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
$ w5 F# ?2 G  z8 w$ l# K- [Regionally, we see the greatest strains on the Prairies,
6 I* y* r* z7 U( }, kwhere housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
5 m7 }0 D  p: S# L$ c; Y* halready 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
3 q. h" X. T2 r( e: V9 Rweakness, will be singed by the downturn nonetheless.
2 g! p0 S) K( E7 E: ?! IQuébec shows signs of strain – especially given the
9 A" M. c9 |( ~8 i# S' Ustrange accumulation of unabsorbed multiples on l’Île de
- u! m8 `# H+ B/ I. U4 ]Montréal – but recent building has been relatively balanced,
given the province’s history of under-building and low ownership
/ J, N# M" x( E; R" x- [8 S" ?rates. While Ontario homebuilding will reel from a
+ A; F, G" X1 Z2 x* b7 _7 Ncyclical downturn, the degree of structural weakness appears
/ d3 ^7 P4 N! }7 ?7 Hlimited – with the important exception of the Toronto
; f: e1 |7 w, l. ?) Lcondo market. Both in Toronto and Vancouver, historically
, M! N9 U% E5 e. _5 n( phigh levels of apartment-style units presently under
! s( K3 b8 b5 \  O8 Tconstruction mean that record numbers of condos will
, X8 L! ~: M# Yreach completion during 2009. If absorption rates fall, as
8 w7 m( \  M( mcyclical 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
" I9 h% w5 @: A- |! `4 Wyears, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
& t) E1 l" n" m; P/ L( yOVERPRICED AND OVERBUILT: CANADIAN HOUSING
+ `+ Z/ S! S. W2 q3 `4 i2 I' j# xMARKET RETURNS TO FUNDAMENTALS
& U7 r3 X0 I2 h5 ?- P1 b" q5 RGrant Bishop, Economist
( O9 T2 o3 W, a' b: T' l416-982-8063
' _$ e) T% \! M3 A3 v+ uPascal Gauthier, Economist
416-944-5730

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

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