TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
% Z0 O6 M0 m8 r: }/ kfrom 2002 to 2008, unsustainable price increases drove
unsustainable levels of building. Our view is that house
! P& F  s# O! t! eprices exceeded the value of housing that was justified by
, J: j0 E0 W9 m9 ~. _0 ~) i9 {& Jfundamentals 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
three years.
By “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
+ r# |6 ?0 c- d) `: P7 u6 uaffordability. The current unwinding of house prices reflects
0 x  _# ^5 r6 Z# e2 Q; dboth a cyclical downturn and a return of house prices
# V' s5 T1 u2 _) C! y2 _0 l+ m; R; tto fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
where 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
5 R# y' w5 P* z0 _3 w' `1 d4 B“overbuilding” was mainly of the first type, where
; j: Y8 q# c0 f: Rhomebuyers pushed homebuilding to an unsustainable pitch
) C$ M; `/ I9 n4 }that is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
! h" T+ V( f, i4 s8 f( 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
) h  I2 R5 Y4 H9 r& b5 o6 Ifrom the cyclical downturn, house price growth will
remain choppy and new residential construction will be
5 M7 X& I9 O9 O7 ?6 x+ {+ Hdampened, owing to this structural weakness. Construction
* D1 L! Z4 v2 j. s" \. c) {is now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
residential construction will fall further to around
9 {/ J6 w7 O5 J9 [1 ^) `125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
To quantify the degree of overpricing and overbuilding,
; G4 v* K) g/ @0 ?3 q% {we first develop an empirical model, based on long-run
! J; N) k$ {% Tfundamentals of house prices and housing starts in each
province. Affordability is the key concept behind home
/ f. }* \0 D% h- k, J. yvalues since house prices should track incomes over the
: N9 [. d+ a  b) N/ d3 M5 x. Olong-run. Since homebuilders build to meet demand, we
6 V: w3 H, S1 P0 D( pregard 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
0 |, {' H$ x7 e5 V6 ?* Owould have occurred if housing had been priced
4 Q2 U& a9 v% J; doptimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
  H& m" v' b% c4 F. t/ o' sRegionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
7 @# P2 J7 b4 ralready witnessing surges in their unsold new homes at the
very time that the resale market has swung into strong
buyers’ territory. Homebuilding in the Atlantic provinces
0 ]. ^* R5 P2 [+ `$ Z( Ghas been relatively balanced but, while not plagued by structural
* E8 x. L  k  e% uweakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
4 U  z/ H' z0 `* Astrange 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
5 h: y) ~  L8 H5 e- {  z1 E/ n7 ]rates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
5 w1 e: f5 @6 C+ Mconstruction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
3 J, L5 X6 L* A8 K# o! q* A& C" a) ncyclical factors would indicate, condo inventories could
2 r. g9 S# h, z9 U& Sspike severely – particularly in Vancouver. However, while
% m4 d  d( Y" n) g9 ]! |4 x7 K8 _8 p* [residential construction in B.C. will definitely droop, we
/ X0 m; T: z. b& V! Lanticipate that the West Coast will continue to benefit from
+ O! q1 J: y6 n$ g9 u9 V( r: Cinter-provincial and international migration over the coming
( k9 C( j3 M; O6 wyears, which, along with improvements in affordability,
; K3 [9 y/ ]& |1 z- g; F- l# a3 lwill alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
2 t/ Z# ^* \2 V% k7 d, lMARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
% Y$ X$ _; C1 J416-982-8063
0 U) d. t' ?" q: kPascal Gauthier, Economist
% Y* m# r& _+ A  `- w( g/ p416-944-5730

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

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