TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
0 n, A  T! c: G- v/ l" Wfrom 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
4 v) n& j" M* P7 x) @8 \overpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
7 c$ D4 m, ]/ c  v8 bthree years.
8 I$ x  B9 U. }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
! V  C7 \6 s' r' |to fundamentally justified levels.
. i* `  ?1 T$ u4 JWe consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
8 K- {: s( \9 w. N$ Iwhere builders accumulate excessive inventories. Although
" z- J' b8 z! s- w3 Ithere is evidence of both types, we contend that Canada’s
) A# r: B3 J  r& N  g“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
" d! I+ j0 R6 a) e0 }the construction of too many new homes over the boom
means a deepened slump. This overbuilding will likely weigh
7 \* {, W1 z. C  K6 U7 Mon markets over the next few years. Even as Canada recovers
from the cyclical downturn, house price growth will
1 ?  Q' p+ R: `8 K2 c& z6 y8 Zremain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
8 R3 V; `, T1 L. Y. w7 C' qis now undershooting fundamentals and we expect this
# W: p/ C2 {" \0 A7 j# N3 V% V% Fto persist over 2009 to 2011. We anticipate that nationwide
residential construction will fall further to around
% O: A# a, d$ y& ]! H125,000 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
" P3 F8 @/ S% `5 qvalues 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.
' x4 t5 t/ p8 J+ ^: xTo examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
- A/ i8 g7 P5 z1 l/ n9 ewould have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
1 O& J7 d0 G* ]fundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
; L9 s9 o" B0 \0 M( V/ vmany houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
  R/ @# g, S7 ~8 |where housing demand will further contract under waning
8 u* v5 `! F0 J& U  h& zpopulation inflows. Saskatoon, Calgary and Edmonton are
1 Q& f, P$ s% X5 }- Y* F8 @2 A0 A- Ialready 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
+ z0 `, K- c1 Whas been relatively balanced but, while not plagued by structural
6 o/ Q# q( ~5 M# vweakness, will be singed by the downturn nonetheless.
* U; `- M; v* Q$ F" WQuébec shows signs of strain – especially given the
strange accumulation of unabsorbed multiples on l’Île de
& Q: k" ^# z$ p0 UMontréal – but recent building has been relatively balanced,
$ h; {8 x3 q5 W4 mgiven the province’s history of under-building and low ownership
rates. While Ontario homebuilding will reel from a
# D2 \" O/ n3 P- t, s- fcyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
8 |5 W# U7 L" Y0 s4 gconstruction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
' b; }8 ?1 a. p& W& Zcyclical factors would indicate, condo inventories could
) G! y7 s9 |* xspike severely – particularly in Vancouver. However, while
: w) ?: v2 |6 R6 V  c& F7 Rresidential construction in B.C. will definitely droop, we
$ o+ @$ R1 [+ U/ ?anticipate that the West Coast will continue to benefit from
: N% V1 }) q0 [inter-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
; \& x2 B' d1 j3 GMARKET RETURNS TO FUNDAMENTALS
& d, ~) I1 R9 N7 r( H2 bGrant Bishop, Economist
9 P7 e5 }% `# x: @416-982-8063
Pascal Gauthier, Economist
416-944-5730

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

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