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
fundamentals by approximately 9% nationwide. This
8 z7 }* M- t- V2 G; Foverpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
, i% ^7 y: t% d2 |4 y12%, an excess that was exaggerated in the past
- X" f+ k* X0 Fthree years.
3 I/ \7 H" t$ Y0 j4 k' s2 X4 w: sBy “overpricing” we mean that prices detached from
8 t3 X: Q! A4 P. w: i5 d$ E+ T; `their fundamentals, as witnessed by a steep erosion of
. h6 A' e8 O1 j4 B* u3 U* F) zaffordability. The current unwinding of house prices reflects
both a cyclical downturn and a return of house prices
to fundamentally justified levels.
# n- C8 Q: m# {) U. m# T' a( iWe consider “overbuilding” of two forms: “demanddriven”
& _- A5 Q" E+ X0 G$ ]/ I! Ewhere homebuyers buy up too many houses and
that 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
# N1 O( x& t/ B& t- `6 K“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,
0 I/ U2 l7 X" s, F$ E8 @& Ethe 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
# i1 O9 f5 O! k5 p1 l9 }+ ]% ]& gremain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
' t8 m& n- e) C* H5 T. p- Y2 Z! [is now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
/ Y; R$ |: ^1 q6 Z! z$ gresidential construction will fall further to around
1 V8 b3 o) i% [) s9 d( z125,000 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: Ofundamentals 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
long-run. Since homebuilders build to meet demand, we
regard housing prices and household formation as the drivers
6 Y; K  U& P* t5 F: w% Gof residential construction.
To examine the degree of overbuilding, we employ a
5 k. J  f! B7 T. D7 c! C+ b“counter-factual,” asking what level of residential construction
9 e8 h( @' ^; q( L# J0 p: Bwould have occurred if housing had been priced
( y* R+ }7 n) x; g) |optimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
* P+ L5 S) @3 v" j0 f9 qunits were being absorbed, homebuyers simply bought too
2 |$ D4 y/ M9 h' f# x" n5 mmany houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
$ ]. i1 V- G! F# T, E$ P6 {1 x# Awhere housing demand will further contract under waning
# _) Z6 n1 c4 F; Y7 X) Y+ n! Ppopulation inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
  W" _+ F, D- S; b# ~4 Kvery time that the resale market has swung into strong
buyers’ territory. Homebuilding in the Atlantic provinces
has 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
) J1 ]4 E7 Y" Z: j7 c8 W' T5 L# e' Istrange accumulation of unabsorbed multiples on l’Île de
* P$ H" @. ~: }" g7 Q4 C3 R: V( oMontréal – but recent building has been relatively balanced,
! @( K& d* b$ [& egiven the province’s history of under-building and low ownership
8 ~0 I5 O+ M" R& a% _9 [rates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
, d6 Z0 U2 s# \- Hcondo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
construction mean that record numbers of condos will
5 g& l9 h% a' p5 l  f6 h/ |2 @3 F8 creach completion during 2009. If absorption rates fall, as
2 J. k" v0 F3 Q' ]5 M- q3 Tcyclical factors would indicate, condo inventories could
! C9 F3 x  j, Q' J# e4 `7 Y( I8 Dspike severely – particularly in Vancouver. However, while
" V  ~- A/ t" Hresidential construction in B.C. will definitely droop, we
anticipate that the West Coast will continue to benefit from
/ T  v0 _2 f. q! b* ?; |inter-provincial and international migration over the coming
years, which, along with improvements in affordability,
' Q5 `+ K# Q& S' s# fwill alleviate some of the pressure from overbuilding.
' N0 s2 `1 B% ?  k, `2 H' W& eOVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
, d1 H2 u: q# t( F. q- SPascal Gauthier, Economist
: R5 v/ w+ W5 V- h- O416-944-5730

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

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