TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
. ?  B! K& c: D- d) yfrom 2002 to 2008, unsustainable price increases drove
unsustainable levels of building. Our view is that house
* n4 _: K  K/ v9 Rprices exceeded the value of housing that was justified by
. \+ J4 S6 T( C4 E) [1 e- m3 vfundamentals by approximately 9% nationwide. This
6 Z9 a5 ?  J7 ]; K# P0 yoverpricing compelled a level of residential construction
# M7 W" }  @7 [3 w$ f3 _7 n" ^9 c0 zthat exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
" q. S! e: y- Othree years.
By “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
. l4 [# u/ H2 Eaffordability. The current unwinding of house prices reflects
% B3 v+ ?/ M4 b- Jboth a cyclical downturn and a return of house prices
6 _- V, \4 M3 b- R& y  I; Hto fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
* [; o0 Z2 m9 |7 \0 a# Awhere homebuyers buy up too many houses and
7 o% L- k# t, O. E4 a$ O8 dthat this demand cannot be sustained; and “supply-driven”
, t* s3 x$ h- U5 F% Nwhere builders accumulate excessive inventories. Although
/ Q# H. Z7 }$ kthere 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
, o/ \$ k, F& d5 j4 Y1 F5 ethat is now being rapidly reined in.
$ t3 v1 h# j3 Y. G% kWhile most markets won’t face U.S.-style overhangs,
8 d; V. G, X% o) y. z. Hthe construction of too many new homes over the boom
, A9 q* N1 D4 @& rmeans a deepened slump. This overbuilding will likely weigh
on markets over the next few years. Even as Canada recovers
4 P% n8 l# ?+ Q/ `from the cyclical downturn, house price growth will
* e. p5 G/ R, e) U7 s3 Hremain choppy and new residential construction will be
; L) w5 y0 `' J) e7 i! J% ddampened, owing to this structural weakness. Construction
, _: M6 ?0 V6 p- K/ T% E! His now undershooting fundamentals and we expect this
" d" I; x! I2 d* i; [to persist over 2009 to 2011. We anticipate that nationwide
% l; F% T7 X& y- _5 F. I: u; i* ~0 Nresidential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
7 e: ~( j' j% _$ i. P1 _5 ?in the fourth quarter.
6 `' K. Q1 S7 C) m% W* C" I; JTo quantify the degree of overpricing and overbuilding,
8 w( y2 x* [& c$ J* M1 N$ b) Bwe first develop an empirical model, based on long-run
fundamentals of house prices and housing starts in each
/ Y9 i- X  a7 y  zprovince. Affordability is the key concept behind home
values since house prices should track incomes over the
7 [$ K/ i5 N, g1 D" O+ |long-run. Since homebuilders build to meet demand, we
5 Q! ^* k% C! I+ I9 N! }0 v% bregard housing prices and household formation as the drivers
* @; ^  u9 _2 B  h8 z# Xof 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
optimally. We find that actual homebuilding exceeded this
( C  I) R5 ~& G! Efundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
3 t" O: R( }" a5 F6 w  Lmany houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
8 R# T/ d2 h8 b4 D; Bwhere housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
3 x! Z. [' Y- S( Q9 Fvery time that the resale market has swung into strong
1 u* y8 r' C( ^( u! P2 }* h' k; L2 ubuyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
8 h: a6 J  w' \/ t$ W$ ^2 u% K: ]+ rweakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
strange accumulation of unabsorbed multiples on l’Île de
( W  k/ {8 i3 s. H+ CMontréal – but recent building has been relatively balanced,
given the province’s history of under-building and low ownership
/ L2 }  B9 [- g7 |* _rates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
, r0 j' r7 y6 a+ e  q- ^% a/ _condo market. Both in Toronto and Vancouver, historically
6 z. d$ }; X; y* J, t% Phigh levels of apartment-style units presently under
construction mean that record numbers of condos will
reach 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
anticipate that the West Coast will continue to benefit from
inter-provincial and international migration over the coming
years, which, along with improvements in affordability,
. K, `" \4 L/ ~6 F# [) F+ \% Qwill alleviate some of the pressure from overbuilding.
( g" F& u$ r2 C8 @; {OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
3 Q7 e! e* T5 f416-982-8063
) {& w* W) k0 i" qPascal Gauthier, Economist
416-944-5730
. ]& N9 @& \: N" b4 Q# N( w& v
http://www.td.com/economics/special/gb0409_housing_exec.pdf

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