TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
) C. ~- r2 a5 O. rfrom 2002 to 2008, unsustainable price increases drove
6 G/ w+ \+ Q6 |2 Funsustainable levels of building. Our view is that house
% F  j/ l( f6 n2 O) ]# lprices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
6 T9 v: N3 l3 h* q6 Yoverpricing compelled a level of residential construction
6 n2 K* r6 ^, ^  b8 C3 o7 i6 Mthat exceeded its fundamental-justified level by approximately
. ~/ ~1 w  p) L2 w8 O/ a8 G2 Q12%, an excess that was exaggerated in the past
) d0 n: S1 C4 A# s/ w/ ?three years.
By “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
) Z" w- m8 F  X+ C( }affordability. The current unwinding of house prices reflects
both a cyclical downturn and a return of house prices
to fundamentally justified levels.
/ e9 F. |, K% ?$ XWe consider “overbuilding” of two forms: “demanddriven”
: _* r$ \  U  h6 ewhere homebuyers buy up too many houses and
8 E& x' p! B2 z9 f% ethat 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
3 y$ Z1 n1 ]4 D; O0 k% Z5 G8 c“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
0 }  h2 s0 ]8 ?$ @1 CWhile most markets won’t face U.S.-style overhangs,
the 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
- K6 P" v" W4 Lfrom the cyclical downturn, house price growth will
remain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
- w- F  P) K% j1 Ais now undershooting fundamentals and we expect this
, i: M' n! Q# i+ R* X7 z0 Rto persist over 2009 to 2011. We anticipate that nationwide
residential construction will fall further to around
8 P6 y, d; n  Y125,000 starts over 2009 with a trough around 115,000 units
& `- h/ Y& Z" p) ?& R2 Vin the fourth quarter.
To quantify the degree of overpricing and overbuilding,
3 T! U- r: t$ ]8 mwe first develop an empirical model, based on long-run
' c) \7 P* i% M1 z% R0 ?  {2 q( z( f) Jfundamentals of house prices and housing starts in each
province. Affordability is the key concept behind home
( Q% D) K' U! P: C/ S/ Xvalues since house prices should track incomes over the
9 x" ^7 J8 ]7 w1 v& u9 Wlong-run. Since homebuilders build to meet demand, we
regard housing prices and household formation as the drivers
of residential construction.
+ M' T9 ^9 _# h) c3 v! ?To examine the degree of overbuilding, we employ a
4 |5 v! ~8 Z. }% m4 x4 `* a! {  q“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
& {5 h9 C# j% Z, b: afundamental-justified level by about 12%. Although new
+ g- e5 s  Q5 i% Aunits were being absorbed, homebuyers simply bought too
9 r# N6 R7 d8 ]7 Gmany houses at prices that exceeded fundamentals.
8 }0 ~( V6 J5 `& d/ dRegionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
1 _7 A$ B4 W" T3 x' Qalready witnessing surges in their unsold new homes at the
very time that the resale market has swung into strong
& r% S7 f% ?0 D% _buyers’ territory. Homebuilding in the Atlantic provinces
# t9 [6 V8 x( Y3 d$ f0 k, c; E- Qhas been relatively balanced but, while not plagued by structural
8 D  z; @0 H9 Z& v; H! ?! {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
& @3 A7 Q) M/ L) f) OMontréal – but recent building has been relatively balanced,
! `; Y* l$ ^% J) g6 \) Ygiven the province’s history of under-building and low ownership
; o- Q# L, q) U# k- I6 Irates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
7 d; L4 B8 x: C) xlimited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
1 h, q9 Q+ O. mconstruction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
7 \' h3 G: r9 f( F" w) w2 ~cyclical factors would indicate, condo inventories could
& g8 K  R9 {( m: M- c  |spike severely – particularly in Vancouver. However, while
residential construction in B.C. will definitely droop, we
! B/ L) r, B, [  janticipate that the West Coast will continue to benefit from
- E' k8 U' @3 L6 j* t/ A. n: y, iinter-provincial and international migration over the coming
, O/ e) P8 w, O+ E! y0 Fyears, which, along with improvements in affordability,
4 f! K+ Q1 i; B: j" t, r& ^% vwill alleviate some of the pressure from overbuilding.
* w, U3 v( i& K( q0 sOVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
+ U* \- d& g) ^$ B. y3 P4 x416-982-8063
' Y* T% X7 q9 }Pascal Gauthier, Economist
416-944-5730
" M/ L+ R) O7 ]$ `. {
http://www.td.com/economics/special/gb0409_housing_exec.pdf

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