TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
: n  L  K4 q$ [( o3 i# e& w$ Kfrom 2002 to 2008, unsustainable price increases drove
8 x2 k8 ~: Z! s% runsustainable levels of building. Our view is that house
/ ~, v; y4 A1 f9 yprices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
0 d: B7 Z2 Q. c$ X- s* xthat exceeded its fundamental-justified level by approximately
8 d' j: e1 S) [12%, an excess that was exaggerated in the past
. T( Y- C5 W( T0 N0 K9 x% Fthree years.
& r4 @7 `. c5 b/ pBy “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
6 G2 ~( x, l# t0 l1 j& d! `2 Eaffordability. The current unwinding of house prices reflects
' D4 Q" a' e( _$ a+ d2 sboth a cyclical downturn and a return of house prices
! R! L% p5 R7 m; xto fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
$ A9 `3 z$ y, o4 T- K" F# @that this demand cannot be sustained; and “supply-driven”
% u8 o: \7 _- O# O1 }where builders accumulate excessive inventories. Although
5 k* ]# A" j) P& c- P# _% Y$ a& vthere is evidence of both types, we contend that Canada’s
% i! E- x2 {! n. D“overbuilding” was mainly of the first type, where
) @& v0 S5 j' n6 b0 `% ~homebuyers pushed homebuilding to an unsustainable pitch
6 D- E1 J& |7 _: ]' X0 Hthat is now being rapidly reined in.
3 b- \# ]# k: I4 OWhile most markets won’t face U.S.-style overhangs,
2 _4 W0 P' b, X% p  n7 xthe construction of too many new homes over the boom
8 A- X4 D+ L& l4 [  Imeans a deepened slump. This overbuilding will likely weigh
8 R: O+ I9 Y* L* _8 ~on markets over the next few years. Even as Canada recovers
from the cyclical downturn, house price growth will
8 n! f. b! k) Bremain choppy and new residential construction will be
! }- O+ C- T$ d7 Bdampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
# I7 k* d# X& s& a( ]8 X9 I0 _to persist over 2009 to 2011. We anticipate that nationwide
+ n4 R5 H! I9 O7 Xresidential 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,
5 l/ F5 L, f% d6 \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
1 b9 o) L: w( E) V$ U; Q$ ]long-run. Since homebuilders build to meet demand, we
2 U6 A5 s, }6 wregard housing prices and household formation as the drivers
$ A% c/ K7 X" m# V/ Y% uof residential construction.
  }! m0 S( \! G& [7 I4 E% ?, {To examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
" |' c: P/ R2 B! [  Q/ F& \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
( b2 L; ]" R$ T$ _( Tmany houses at prices that exceeded fundamentals.
6 M* d" F$ A5 V7 ?& W: X1 M# V# aRegionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
* X5 E; j/ Z  ?* E$ ualready witnessing surges in their unsold new homes at the
8 \, e; h# j& ^. j7 M) J# ?' overy time that the resale market has swung into strong
' P+ q4 N; O+ a" p- Ebuyers’ territory. Homebuilding in the Atlantic provinces
$ H! c$ f9 m( h2 Ahas been relatively balanced but, while not plagued by structural
& I7 Q0 Q) e$ s1 Vweakness, will be singed by the downturn nonetheless.
& j2 q" k! [  G$ j  K! ^* P' XQuébec shows signs of strain – especially given the
strange accumulation of unabsorbed multiples on l’Île de
+ S; A# g7 d  ^3 R: e$ mMontréal – but recent building has been relatively balanced,
1 v# d) i8 X* i+ x, p& I. ]1 Vgiven the province’s history of under-building and low ownership
+ m8 K2 h8 Y+ brates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
2 Y" Z$ o; d7 K& j; tlimited – with the important exception of the Toronto
9 v7 p% G0 k- e$ }condo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
, z4 s2 i- V8 H' u3 d, econstruction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
0 N$ G( ]: C6 I2 s3 [. N1 [: dspike severely – particularly in Vancouver. However, while
' Q6 h4 L9 W* _3 k6 q4 C" b4 [6 eresidential construction in B.C. will definitely droop, we
anticipate that the West Coast will continue to benefit from
7 s% g. Y$ i8 |" N1 F& e: S  b$ B$ T4 yinter-provincial and international migration over the coming
2 i$ e; Q5 O# c9 {' ^2 N' ^years, which, along with improvements in affordability,
4 b+ F3 G! y* Z8 f7 t$ `will alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
. t0 A' C3 `/ B# ~1 p9 tGrant Bishop, Economist
) P& y7 u9 T2 j- K: v/ G9 M" g416-982-8063
8 [) S. c6 w# k$ W1 Z9 w$ }Pascal Gauthier, Economist
416-944-5730

% _2 I: e' e+ G% W4 z; {http://www.td.com/economics/special/gb0409_housing_exec.pdf

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