TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
+ g  p4 [  w. d# Rfrom 2002 to 2008, unsustainable price increases drove
+ ?1 _9 b4 o. f9 p. o2 Zunsustainable levels of building. Our view is that house
, c7 M/ D: i' r' i+ I% i3 Nprices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
3 m. w6 L3 a! {  R6 ]: P. S12%, an excess that was exaggerated in the past
0 ^$ G5 A; `2 s* a! qthree years.
8 {5 ^; c7 ~$ ^# i- [& C  mBy “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
, Y; E$ D! |& l8 M7 Oaffordability. The current unwinding of house prices reflects
  R8 l& B" j8 f4 g8 \* M1 cboth a cyclical downturn and a return of house prices
  e- Y( F5 {* gto fundamentally justified levels.
* L$ B: ]& ~8 k% K( |( o! hWe consider “overbuilding” of two forms: “demanddriven”
5 P- l4 k$ ^  u$ r. K. R" Owhere homebuyers buy up too many houses and
9 [) }* Z- d8 v% `6 o+ E3 }; sthat 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
" F/ u2 V4 K; ?4 h' W. D/ v“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,
the construction of too many new homes over the boom
means a deepened slump. This overbuilding will likely weigh
) q! S, s' E  l2 Y+ C/ c/ qon markets over the next few years. Even as Canada recovers
from the cyclical downturn, house price growth will
9 q3 \/ L: P6 A, k. o1 Jremain choppy and new residential construction will be
0 A0 q, G+ t2 y- z: ^' i5 Tdampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
4 c, m/ e: {! A; ?% P" x% kresidential 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
0 G) V' A- q9 H; J! u& p) g( Qvalues since house prices should track incomes over the
- _6 F0 H# U# Q- L. U% U' W, @long-run. Since homebuilders build to meet demand, we
regard housing prices and household formation as the drivers
2 k0 ~; k5 d+ K& E1 U; E2 Kof residential construction.
To examine the degree of overbuilding, we employ a
# Q, @0 _" u8 R“counter-factual,” asking what level of residential construction
4 f/ @. Z/ C# }7 k9 ]& L- j4 F: m9 Qwould have occurred if housing had been priced
4 v" m: h9 J, X2 U, Noptimally. We find that actual homebuilding exceeded this
7 V9 D1 }7 F: g; I* Pfundamental-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,
0 m4 N8 o7 _) G" n) E0 dwhere housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
) Y* K5 R/ }. v3 c4 Ralready witnessing surges in their unsold new homes at the
very time that the resale market has swung into strong
" i1 S( g' L6 t9 F! qbuyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
+ S4 F" }- c/ i5 J" h" nweakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
strange accumulation of unabsorbed multiples on l’Île de
" {; Z. n0 e& ~& R* x' H% |6 t$ mMontréal – but recent building has been relatively balanced,
given the province’s history of under-building and low ownership
. m! ?! w& q0 D; L( hrates. While Ontario homebuilding will reel from a
2 B/ D4 m/ z0 D7 R- ecyclical downturn, the degree of structural weakness appears
7 K, t  P- m' [) ?* r  @limited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
construction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
cyclical 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
years, which, along with improvements in affordability,
- P0 o% b+ ?: _# {$ }9 Uwill alleviate some of the pressure from overbuilding.
: j4 v8 v9 h. A; d3 QOVERPRICED AND OVERBUILT: CANADIAN HOUSING
0 L# F8 S: B, g# W& v+ |MARKET RETURNS TO FUNDAMENTALS
" g$ E0 ]" L9 YGrant Bishop, Economist
416-982-8063
Pascal Gauthier, Economist
8 B  @" t; n6 L4 O416-944-5730

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

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