TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
from 2002 to 2008, unsustainable price increases drove
% n6 X3 {2 W" b; {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
overpricing compelled a level of residential construction
' d! T5 J; l) ]- t( y0 tthat exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
& e6 l$ S9 R% w7 L6 Bthree years.
By “overpricing” we mean that prices detached from
: `# n3 o" `: H" btheir fundamentals, as witnessed by a steep erosion of
* r: ?/ _/ k9 O0 G, [, B! c( T  Jaffordability. The current unwinding of house prices reflects
: `4 u& r6 ]" {$ dboth a cyclical downturn and a return of house prices
1 D0 {2 ~) C. N/ b' b1 o4 U* h6 tto fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
- I2 v& V) z) V' d$ [that this demand cannot be sustained; and “supply-driven”
% a( C; Z* H: s2 }5 b; y7 D( mwhere builders accumulate excessive inventories. Although
3 X$ B5 r5 b- g' E) N& {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
) p( D' c; D3 B8 B" ?" d- Othat is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
$ b$ ?( M3 d' t. {6 V4 Y/ gthe construction of too many new homes over the boom
means a deepened slump. This overbuilding will likely weigh
+ Y& k1 Q1 ?& N8 d! W) y8 B% }on markets over the next few years. Even as Canada recovers
5 ]4 @* _" V- l% mfrom the cyclical downturn, house price growth will
4 B. `& K$ ]$ q/ a  Yremain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
9 K2 q* ]& x8 }1 A. a3 h2 j0 q$ J% i  mis now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
& d8 y! n/ F& G( mresidential construction will fall further to around
/ f0 C6 ~& t& @, \" b$ b* C125,000 starts over 2009 with a trough around 115,000 units
6 ^/ M! M3 E: A# U8 Min the fourth quarter.
/ ~% X5 q) \5 O" w$ |( MTo quantify the degree of overpricing and overbuilding,
: H. d' y; n- z% Z% q/ D: L; |5 awe first develop an empirical model, based on long-run
fundamentals of house prices and housing starts in each
province. Affordability is the key concept behind home
. D/ A# E6 d0 k( U3 o; c" hvalues 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
1 e9 f2 i0 u* i8 t/ Bof 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
( ~, D1 R" m1 W+ e! q) ioptimally. We find that actual homebuilding exceeded this
, v6 s1 H8 z! y# ]/ ^6 Rfundamental-justified level by about 12%. Although new
; J( a6 \& y, n& i7 Q/ Funits were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
6 b, G; |& K  Rwhere housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
8 H- {4 @4 f* Z$ |" S/ |8 Uvery time that the resale market has swung into strong
8 ?: J* n# _! H, N6 M/ z# A$ c2 S4 Ybuyers’ territory. Homebuilding in the Atlantic provinces
$ _% ]& U3 p1 C3 R$ t4 L& R4 Hhas been relatively balanced but, while not plagued by structural
' ^+ g, f5 {1 a! m0 Q* zweakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
; c8 Q' L  w9 estrange accumulation of unabsorbed multiples on l’Île de
& t9 p: d9 S; V- k- _. C% ZMontréal – but recent building has been relatively balanced,
  J5 _8 U+ Y* J4 J# Hgiven the province’s history of under-building and low ownership
rates. While Ontario homebuilding will reel from a
; I1 S) y" p8 ~" ccyclical downturn, the degree of structural weakness appears
1 z: _) b  v, ~/ J) H! {. }6 ylimited – with the important exception of the Toronto
! `7 w( q' l5 @* @: @condo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
& n" c* i6 ^" t. Q5 H" `; Q% Y2 Hconstruction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
7 n  [; W8 C& `. l3 O( z, Ucyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
residential construction in B.C. will definitely droop, we
+ r# M$ c/ R7 Z3 vanticipate that the West Coast will continue to benefit from
8 \, h4 u& b  v3 t: Dinter-provincial and international migration over the coming
' ]: p9 b/ H9 B( z- v7 Dyears, which, along with improvements in affordability,
' N/ `! u8 ?* fwill alleviate some of the pressure from overbuilding.
% M, E; q! W/ J7 }; \* Q' KOVERPRICED AND OVERBUILT: CANADIAN HOUSING
6 b, m" W, N! l- u; m# x; J. U( PMARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
Pascal Gauthier, Economist
( Z! v1 z/ B3 w, ]! W416-944-5730

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

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