TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
1 u4 D& m( J( s# R% Z1 P  afrom 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
! Y. ~5 g0 o- @$ h! yfundamentals by approximately 9% nationwide. This
3 g/ g# G! E2 K; v7 M. ioverpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
three years.
7 H: l) [  u& N6 ?& sBy “overpricing” we mean that prices detached from
( p' U5 e. T- F, utheir fundamentals, as witnessed by a steep erosion of
  l$ D: h! D) v( b; ?affordability. The current unwinding of house prices reflects
& K7 `" k* Z1 r( l9 zboth a cyclical downturn and a return of house prices
to fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
7 a4 ^* K% S! }/ j9 mwhere homebuyers buy up too many houses and
0 I9 [4 o/ @' p' @& z; G$ ~4 Xthat this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
1 _- }8 P' ?' Nthere is evidence of both types, we contend that Canada’s
6 P1 t) _3 u# s, X  e& Y4 f  w“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
' e) w( G- m( h6 r8 UWhile most markets won’t face U.S.-style overhangs,
# M  L: x! ?$ Xthe construction of too many new homes over the boom
7 u( k5 q# G# Z7 `means a deepened slump. This overbuilding will likely weigh
2 Z( p  _2 Z9 _on markets over the next few years. Even as Canada recovers
& ~0 E$ h9 {, y+ @) Bfrom the cyclical downturn, house price growth will
remain choppy and new residential construction will be
. M1 ?9 H* P% v) K" g" x" Jdampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
to 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
7 f, O; Z) B8 Z# ?4 ~% c4 V2 p8 }in the fourth quarter.
' _5 ]3 F" B2 C1 x& [4 X, J1 hTo quantify the degree of overpricing and overbuilding,
we first develop an empirical model, based on long-run
( ?7 _& e- ~/ L# A7 w( Wfundamentals 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
long-run. Since homebuilders build to meet demand, we
regard housing prices and household formation as the drivers
+ Z* J9 ?3 ^8 _- L& |of residential construction.
+ e) S9 C2 ?* D0 P+ j- {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
optimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
6 t1 g1 t. d1 y1 omany houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
, M! _, W1 v: P9 @, Xpopulation inflows. Saskatoon, Calgary and Edmonton are
already 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
' W2 Z! }! R# a  a3 q# ?weakness, will be singed by the downturn nonetheless.
1 B, {$ o$ T3 C% f1 q' R$ ?; Z+ F4 aQuébec shows signs of strain – especially given the
  z0 v& N. }; i6 e4 Q: y% d( B! |strange accumulation of unabsorbed multiples on l’Île de
1 u7 u. F/ H  d+ M3 jMontréal – but recent building has been relatively balanced,
2 o5 _- S5 [6 |0 @8 Q- bgiven 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
limited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
, W1 M3 T5 i" T0 _  R+ Shigh levels of apartment-style units presently under
construction mean that record numbers of condos will
  y3 G* x6 Z1 q1 e8 F3 t% Z' a; |reach completion during 2009. If absorption rates fall, as
4 g% X9 Z! j# Kcyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
% ~1 I: K' H3 }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
years, which, along with improvements in affordability,
+ B  a- a/ y3 h& A; V5 M/ S& Iwill alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
: o$ A' X( B) q. d! S- A7 OGrant Bishop, Economist
+ z+ h4 G0 `6 C: E416-982-8063
  I* Z/ C# }" `4 D3 R6 t$ jPascal Gauthier, Economist
416-944-5730

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

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