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
  ]! G( h7 M. h) }& H% ffundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
1 A! `+ m0 L/ y& Vthat exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
  M* @0 O7 \+ o/ m3 qthree years.
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
to fundamentally justified levels.
! g3 n' Q+ m' Y/ @) zWe consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
3 J7 s3 P4 Z; n8 ~3 Vthat this demand cannot be sustained; and “supply-driven”
8 w. i" O4 J5 u, r+ cwhere builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
/ A. t' G! J2 G, ]homebuyers pushed homebuilding to an unsustainable pitch
$ r# s" p6 k4 R7 G5 O  C# a# Q! zthat is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
' k' g5 V5 O5 x1 Q& Othe construction of too many new homes over the boom
/ Y: q& w/ ?! tmeans a deepened slump. This overbuilding will likely weigh
4 U6 Z; Y- e% ]' ~on markets over the next few years. Even as Canada recovers
/ t( S& v( ^9 @1 k8 v; k. |6 Ifrom the cyclical downturn, house price growth will
remain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
3 Y) x' l% U+ G+ f  Gis now undershooting fundamentals and we expect this
. o" {7 E; g$ o6 X+ U$ Pto persist over 2009 to 2011. We anticipate that nationwide
residential construction will fall further to around
8 `3 z* f( r& o) b9 W3 n1 n125,000 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
- P: i' T" Y9 N" y* p& hprovince. Affordability is the key concept behind home
values since house prices should track incomes over the
: f9 p+ e2 w3 Rlong-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
“counter-factual,” asking what level of residential construction
8 x" m  o4 z# s3 \: Lwould have occurred if housing had been priced
( h) I: f5 ?% Y7 Q1 U1 foptimally. We find that actual homebuilding exceeded this
7 s; f+ p# g; O' x( P1 |. X% p- Y0 _fundamental-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,
where housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
% f7 v/ i9 d* ralready 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
2 \2 C7 h5 n- }7 B7 H$ N- shas 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
strange accumulation of unabsorbed multiples on l’Île de
5 I1 I5 l# j5 M# cMontréal – but recent building has been relatively balanced,
given the province’s history of under-building and low ownership
rates. While Ontario homebuilding will reel from a
" q1 ]2 X8 u. Z! V4 d* }8 jcyclical downturn, the degree of structural weakness appears
0 I$ X# }' u7 z  z4 @limited – with the important exception of the Toronto
, ~% K' R7 ]* F. a1 ?3 Ucondo market. Both in Toronto and Vancouver, historically
$ v" e# k7 Z3 K( z3 jhigh levels of apartment-style units presently under
) d% \$ f: ]) n0 u; `construction mean that record numbers of condos will
  L4 c: r! e' L" w) Q9 Hreach completion during 2009. If absorption rates fall, as
5 f9 m; x! [& U( A- e0 C2 j& Vcyclical factors would indicate, condo inventories could
0 [! E( ?& J  J) o- zspike 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
years, which, along with improvements in affordability,
+ I: ~1 R6 N( ~6 {2 Mwill alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
: c! u  g- j2 BMARKET RETURNS TO FUNDAMENTALS
: Z, T/ n. c# f' j* mGrant Bishop, Economist
416-982-8063
Pascal Gauthier, Economist
416-944-5730

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

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