TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
) B9 |# W- W5 G- `1 x5 I6 Jfrom 2002 to 2008, unsustainable price increases drove
unsustainable levels of building. Our view is that house
- G% ?9 e3 `( c$ {8 u/ G3 o8 nprices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
# B. n. ~# v, _) {1 R3 Y+ V- L- jthat exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
1 o7 A$ m) R1 K# Rthree years.
, F8 P) Z) s9 _, R0 u: f) L; SBy “overpricing” we mean that prices detached from
% z) Y0 \, W6 {- t& Ytheir fundamentals, as witnessed by a steep erosion of
" e4 E& g- e2 g' d" u6 `. s: C+ yaffordability. The current unwinding of house prices reflects
% y; E7 t) L9 Y. P* R5 m$ v( V0 }5 fboth a cyclical downturn and a return of house prices
to fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
  E( ~! k5 g0 B# G# i. w( a: Sthat this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
* p% ^0 ]  v& g! S% q! j9 Zthere is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
6 t8 C. K- [, s8 U# qhomebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
. C+ k+ a$ v; S. p! f% o6 o, CWhile most markets won’t face U.S.-style overhangs,
' _0 G7 ^- }8 {( _# ?the construction of too many new homes over the boom
" v$ h& U  n+ ^means a deepened slump. This overbuilding will likely weigh
0 i* q  W7 A4 e+ P( p' @' x; ~: gon markets over the next few years. Even as Canada recovers
% o7 h9 i) p# X9 Dfrom the cyclical downturn, house price growth will
remain choppy and new residential construction will be
1 \- u6 K, Z) Z8 p9 wdampened, owing to this structural weakness. Construction
* ]4 E/ _2 A) ^3 W7 i" qis now undershooting fundamentals and we expect this
0 W; N$ V; f3 }. D. _to persist over 2009 to 2011. We anticipate that nationwide
; v* F( @% s, }- F2 l; Nresidential construction will fall further to around
9 l3 U3 |8 w& _( N4 l125,000 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
) z  w, y# a0 f/ Z# R0 D# }province. Affordability is the key concept behind home
values since house prices should track incomes over the
( {8 \8 p7 m/ B2 J- `7 Mlong-run. Since homebuilders build to meet demand, we
6 j: n/ X; m9 `7 h' ^( {regard housing prices and household formation as the drivers
of residential construction.
$ c+ O3 ^, X+ R$ XTo examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
& V" R1 \7 f( n" p% H0 |optimally. We find that actual homebuilding exceeded this
3 F; b9 V: a& L5 f) t, Ffundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
! ~! ~0 M+ v+ T/ Amany houses at prices that exceeded fundamentals.
4 T) K. e/ q0 ?9 @Regionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
4 _4 \3 W8 n" t$ Mvery 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.
$ v- N7 P  t" U- ?* f. A6 D9 d- J; sQuébec shows signs of strain – especially given the
strange accumulation of unabsorbed multiples on l’Île de
Montréal – but recent building has been relatively balanced,
7 f% B" }- J' b+ @given the province’s history of under-building and low ownership
rates. While Ontario homebuilding will reel from a
$ w$ z8 D& t+ {4 J& x( @cyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
% D2 W2 O2 V1 X6 K3 g+ ]/ bcondo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
construction mean that record numbers of condos will
, ~5 C" S+ P  Z$ [: D2 ^reach completion during 2009. If absorption rates fall, as
7 G* n8 _% H5 s+ a% Jcyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
# w8 x- S* X& J6 qresidential construction in B.C. will definitely droop, we
0 K. v% Z; i, a' z* hanticipate that the West Coast will continue to benefit from
inter-provincial and international migration over the coming
$ U5 g* U% w' @4 W7 ^years, which, along with improvements in affordability,
! \) D0 {: n3 d% j9 @- bwill alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
8 w9 _. m& c- BMARKET RETURNS TO FUNDAMENTALS
' b  _* f' B( ?2 I- iGrant Bishop, Economist
416-982-8063
Pascal Gauthier, Economist
; P# c; K+ r/ I$ V416-944-5730

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

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