TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
0 L( Z" G& r' K2 _from 2002 to 2008, unsustainable price increases drove
unsustainable levels of building. Our view is that house
* R5 j7 s: c; ?( m; K4 zprices exceeded the value of housing that was justified by
  F$ \! Y7 L, L& m; h3 p5 Ifundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
6 d1 v* U$ f% x* a# ?three years.
. {8 v6 b! n% ?& H0 gBy “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
2 h5 X; J7 B- P! maffordability. The current unwinding of house prices reflects
both a cyclical downturn and a return of house prices
to fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
. ~& O5 F+ X) swhere homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
, \) q0 }! n! W0 |! u5 v- Mwhere builders accumulate excessive inventories. Although
$ o7 [6 i6 e. d9 V( Xthere is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
( A8 ^- y3 [9 y6 Shomebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
$ I3 P. K9 G+ F. [( u) Z" Othe construction of too many new homes over the boom
means a deepened slump. This overbuilding will likely weigh
on markets over the next few years. Even as Canada recovers
from the cyclical downturn, house price growth will
remain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
. A: x; e3 y+ T, x# d( |9 u1 {is now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
  o+ M' r: f2 I; Iresidential 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
) r. Z* }" Z% @* a9 a+ q7 @fundamentals of house prices and housing starts in each
4 ?& f) ]% S) B9 v6 e/ Iprovince. Affordability is the key concept behind home
values since house prices should track incomes over the
! f/ G0 X- T: w0 b/ p0 olong-run. Since homebuilders build to meet demand, we
; z, o) a5 t0 N8 r- _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
would have occurred if housing had been priced
. ]  D' @8 x: u. Ooptimally. We find that actual homebuilding exceeded this
+ B# M* u1 g) w  m! a/ cfundamental-justified level by about 12%. Although new
+ R# ^2 W0 C. ~) ]+ l  kunits were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
0 D5 {! f% O, E  M4 uwhere housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
7 M7 W6 @* {2 s% @0 u" }" S/ V  yalready witnessing surges in their unsold new homes at the
very time that the resale market has swung into strong
: d# L& {) _6 L9 ]. Z) B, V/ Rbuyers’ territory. Homebuilding in the Atlantic provinces
; a5 G7 G) p; S% ohas 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
, V% F- a% B9 estrange accumulation of unabsorbed multiples on l’Île de
Montréal – but recent building has been relatively balanced,
given the province’s history of under-building and low ownership
* e4 R6 {& v+ `+ r/ M) x: Wrates. While Ontario homebuilding will reel from a
4 r) `2 W2 y& i9 [' ]" Tcyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
( w0 ]# d+ ?) |! G: b& v) k) Ehigh 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
7 O$ i) W6 R8 w0 dresidential construction in B.C. will definitely droop, we
4 P8 g3 y9 \; n7 yanticipate that the West Coast will continue to benefit from
+ i' E9 \$ |9 c4 P( cinter-provincial and international migration over the coming
5 K" q$ s8 ~% r6 r+ Uyears, which, along with improvements in affordability,
" E. {$ m" v/ S# m8 u- }/ cwill alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
0 \% d! z) M: t. `3 a9 ?MARKET RETURNS TO FUNDAMENTALS
9 w8 H9 p' e: j' n; RGrant Bishop, Economist
416-982-8063
Pascal Gauthier, Economist
4 M+ V1 a8 R* ]7 z416-944-5730
$ Q. A6 s; ~! N
http://www.td.com/economics/special/gb0409_housing_exec.pdf

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