TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
& Y8 V% I" Z9 Y* ]: a7 zfrom 2002 to 2008, unsustainable price increases drove
& j  H; o4 l5 I! kunsustainable levels of building. Our view is that house
5 s/ [  }3 a6 i- p3 lprices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
$ V: z2 D, \+ ~8 j( Soverpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
" {7 Z, b, f7 o( J: ithree years.
By “overpricing” we mean that prices detached from
. p4 U, Q+ X: w! @# N7 Ptheir fundamentals, as witnessed by a steep erosion of
' A' @- j/ u" c, d1 j8 maffordability. The current unwinding of house prices reflects
6 o4 J5 m4 }, j3 m- q: o( r! Rboth 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
that this demand cannot be sustained; and “supply-driven”
3 a* R5 |; r4 [( N  v9 Uwhere builders accumulate excessive inventories. Although
! g2 D7 u* ]" }1 [there is evidence of both types, we contend that Canada’s
0 O% j; c, ?  Y" t; \“overbuilding” was mainly of the first type, where
7 e; U/ A6 ^* _# Q  y. y6 Q* lhomebuyers pushed homebuilding to an unsustainable pitch
7 ?1 j# y& Z8 D, P$ @& Lthat is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
) D9 W6 v! Y, x: X# lthe construction of too many new homes over the boom
- T. g: @! O+ B% Mmeans a deepened slump. This overbuilding will likely weigh
% K, }9 Y, R# k  [% i+ g4 w" Lon markets over the next few years. Even as Canada recovers
* s. ], ~  k5 N' k! {from the cyclical downturn, house price growth will
remain choppy and new residential construction will be
! d9 A* P" l, o. I- W0 Ndampened, owing to this structural weakness. Construction
% {. ^( w* f% h5 R( s+ M3 Xis now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
residential construction will fall further to around
( w7 A! F7 M7 j" u$ \125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
To quantify the degree of overpricing and overbuilding,
# E) n2 R# e, t, P5 r: xwe first develop an empirical model, based on long-run
fundamentals of house prices and housing starts in each
2 ]' h/ z5 f& k5 Pprovince. 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
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
0 k: D$ }4 {+ y: u- @# ^optimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
& t0 ^& d8 U( ?2 ?2 j8 ymany houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
3 i* U4 d5 ~* ~- h3 K$ `' Awhere housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
' K9 h( z9 m, j4 {: C+ D$ Falready witnessing surges in their unsold new homes at the
! q# |8 k% m" cvery time that the resale market has swung into strong
( X" p. d  q& C0 l1 M. A9 C' S& K! D1 }buyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
$ H% P7 U' c* I3 P7 J8 H9 {weakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
strange 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
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
construction mean that record numbers of condos will
' i' ~1 y% Z7 f+ Z. C7 \' jreach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
: P2 |+ P: P/ i+ |, r) o% Hspike severely – particularly in Vancouver. However, while
% d7 W, W; _# m2 w# A9 v$ a* wresidential construction in B.C. will definitely droop, we
1 X# K; f+ I$ u9 U4 N7 v- x6 ranticipate that the West Coast will continue to benefit from
5 a. z! P& @+ u3 Q" {# hinter-provincial and international migration over the coming
years, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
) F  R5 z+ h2 }7 y% a% j& u5 EGrant Bishop, Economist
5 H9 r( x+ M* q0 Y* L- W+ z416-982-8063
Pascal Gauthier, Economist
3 e: _# V+ l$ F416-944-5730

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

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