TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
( [( |% L2 l) J* N$ T; dfrom 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
# u- K' Z* i" j7 \9 S* q  X5 Foverpricing compelled a level of residential construction
- N4 M) y& F3 Q+ ?that exceeded its fundamental-justified level by approximately
% G) Y  w/ r8 Y* ^, n1 v. P) ^0 B+ B12%, an excess that was exaggerated in the past
three years.
9 l% l4 H' T& |+ Z  m1 D, m  c, Z6 kBy “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
( ?) [" p+ ~2 U+ u% K9 laffordability. The current unwinding of house prices reflects
both a cyclical downturn and a return of house prices
' o6 }( _% v- H- j7 oto fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
# t' z# w3 n4 O* X3 t& ithat 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
“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
/ Z( ~9 }% t8 lWhile most markets won’t face U.S.-style overhangs,
" Z1 c9 A3 M; tthe construction of too many new homes over the boom
means a deepened slump. This overbuilding will likely weigh
: [5 Z. ~" |3 b% G2 y" w) ?( uon 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
is now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
$ @8 R% L5 Q0 Fresidential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
1 h# A9 D9 T* {2 \, qin the fourth quarter.
1 P# u" E8 o; X4 a+ D& c( G0 oTo quantify the degree of overpricing and overbuilding,
5 o  c1 @1 u+ S# i1 |we first develop an empirical model, based on long-run
( i1 ]! F3 q) Xfundamentals of house prices and housing starts in each
province. Affordability is the key concept behind home
( R. @" H) f. O1 P$ a: N( l- qvalues since house prices should track incomes over the
8 F% E1 W. @/ X4 G( ylong-run. Since homebuilders build to meet demand, we
8 M% a8 H' N/ s  k. u; E8 t% c5 Dregard housing prices and household formation as the drivers
of residential construction.
To examine the degree of overbuilding, we employ a
- K4 `! O  C: K“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
* C; G2 s4 H5 o# Y/ k- D6 X) L* Junits were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
- v: _( l% ^8 \, `5 q  B& [; r! BRegionally, 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
9 y" o* x& f. g' D# q  |9 Dvery time that the resale market has swung into strong
buyers’ territory. Homebuilding in the Atlantic provinces
8 B9 f8 s) D: x" `has been relatively balanced but, while not plagued by structural
" x; Y& `$ c/ j+ Z9 nweakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
% {. M2 G: B0 N/ D8 g5 sstrange accumulation of unabsorbed multiples on l’Île de
Montréal – but recent building has been relatively balanced,
" y2 G- }9 e, [" B5 s& E) egiven the province’s history of under-building and low ownership
/ A6 L& |* w% B. B$ H' drates. While Ontario homebuilding will reel from a
, D. z+ S+ [" v2 O$ ycyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
4 T' v3 l! ]6 f# y  L5 c' m( kcondo market. Both in Toronto and Vancouver, historically
7 O; ~( L! y) T9 S% L8 Rhigh levels of apartment-style units presently under
5 L  y2 O. C$ e, Vconstruction mean that record numbers of condos will
0 l+ T. P8 q9 N, U3 Oreach 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
: U4 O1 H4 r- N  M" M# santicipate that the West Coast will continue to benefit from
inter-provincial and international migration over the coming
years, which, along with improvements in affordability,
  q5 m/ R! e2 f/ w6 e$ ]4 jwill alleviate some of the pressure from overbuilding.
8 c% X, e% c  MOVERPRICED AND OVERBUILT: CANADIAN HOUSING
, _; o1 d5 p6 C: C$ a' gMARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
1 `) a# L' O) M0 _' f. ^' i416-982-8063
* v' s+ @1 J  [Pascal Gauthier, Economist
6 S) ?8 v; G/ d! \. _9 @7 ?416-944-5730
+ v  }5 l- G) V6 K; F5 P
http://www.td.com/economics/special/gb0409_housing_exec.pdf

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