TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
: i) B, g+ D7 w* r( tfrom 2002 to 2008, unsustainable price increases drove
unsustainable levels of building. Our view is that house
prices exceeded the value of housing that was justified by
: t9 J: s" g7 ~9 K: c7 q( K( G9 Ffundamentals by approximately 9% nationwide. This
' P4 E/ O% i3 ^( ~0 w) ]9 U( qoverpricing compelled a level of residential construction
1 d, E1 [, r) ?. ]5 [, U0 uthat exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
6 C1 I% I- T( U( v& ethree years.
By “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
both 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
7 {* Z3 R3 E( y9 Cthat this demand cannot be sustained; and “supply-driven”
2 [& z9 X" c* v: d  R, Ewhere builders accumulate excessive inventories. Although
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
that is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
/ ~! z& i% p3 B. qthe construction of too many new homes over the boom
means a deepened slump. This overbuilding will likely weigh
7 k* [0 d9 e) P1 M6 @on markets over the next few years. Even as Canada recovers
from the cyclical downturn, house price growth will
remain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
2 p0 u& s8 y4 J. W( ]* Gis now undershooting fundamentals and we expect this
" [  h6 ]3 f6 Oto persist over 2009 to 2011. We anticipate that nationwide
( D$ `+ @9 K  z5 a7 m, t; Q; Oresidential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
) b# ?; t, F2 N6 z% B8 V5 bTo quantify the degree of overpricing and overbuilding,
we first develop an empirical model, based on long-run
fundamentals of house prices and housing starts in each
# a5 p1 M. U/ H; P, y6 Oprovince. Affordability is the key concept behind home
, t: |" S1 G1 `4 O0 g& D- hvalues since house prices should track incomes over the
0 _" \- ~. r) j  Clong-run. Since homebuilders build to meet demand, we
regard housing prices and household formation as the drivers
of residential construction.
; ?" R3 Z$ R3 Z; o2 q1 c0 bTo examine the degree of overbuilding, we employ a
( W( M( }3 H# {- ~8 ]4 p; K“counter-factual,” asking what level of residential construction
- w6 V  s5 |5 j& Q- ]' S9 V. B( Rwould have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
: h, J1 _5 @4 y. r2 r! \5 Ffundamental-justified level by about 12%. Although new
% }. \8 a2 [* M6 T! junits were being absorbed, homebuyers simply bought too
( |- r% N8 m7 R8 B9 j7 `/ \; Lmany houses at prices that exceeded fundamentals.
2 p/ ~0 D! x+ p9 j+ q% uRegionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
8 F) b0 E" Y) i2 I7 A5 G% ppopulation inflows. Saskatoon, Calgary and Edmonton are
! |, r! _* j+ kalready witnessing surges in their unsold new homes at the
+ {* D3 O) w  \- `1 wvery time that the resale market has swung into strong
* \* m9 b  n/ q# e# x2 o+ gbuyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
& [/ }/ h- l& t9 D4 G8 tweakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
0 C2 ?! `6 O( ^strange accumulation of unabsorbed multiples on l’Île de
Montréal – but recent building has been relatively balanced,
8 X9 h1 D# O3 u& I+ O: r! ygiven 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
! ~$ O6 \/ P# F5 b! u* S- Xlimited – with the important exception of the Toronto
" b0 C" W) m5 q" j5 N! n) d4 z2 scondo market. Both in Toronto and Vancouver, historically
# H1 G5 Q" @1 L( Q! ?high levels of apartment-style units presently under
construction mean that record numbers of condos will
* Z! u2 }8 U1 u* q# Zreach 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
! y5 y6 P% v( D" n0 |; Jinter-provincial and international migration over the coming
0 t! \* _+ a) y4 G; \) Syears, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
3 J: d) h. o( M8 ePascal Gauthier, Economist
+ u( e$ y$ k4 M, C3 |2 `# @416-944-5730
% v5 [# m. t% V- b- t+ W
http://www.td.com/economics/special/gb0409_housing_exec.pdf

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