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
* P( w2 `4 t! E& O4 ounsustainable levels of building. Our view is that house
, y1 D, T) [4 A3 U8 P: Fprices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
three years.
By “overpricing” we mean that prices detached from
) P4 |2 w! h- O% s& n/ qtheir 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.
$ O' y+ q" v, B, H/ G6 SWe consider “overbuilding” of two forms: “demanddriven”
! \. v' p" w$ \where homebuyers buy up too many houses and
that 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
) `' b2 E( G, p: M% t. Q“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
* J! b# @* }, y$ [- f$ a7 pthat is now being rapidly reined in.
1 ^8 D, z/ j& dWhile most markets won’t face U.S.-style overhangs,
5 v* V& Q+ a* m+ Cthe 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
8 ~% G4 F- [2 _) ^from the cyclical downturn, house price growth will
remain choppy and new residential construction will be
3 p3 P# b6 R+ U) F/ w9 N9 Qdampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
" P5 W6 Z7 Y% a) Presidential construction will fall further to around
! h. e0 B1 y: t  n$ o: g, x125,000 starts over 2009 with a trough around 115,000 units
# ?5 E8 G- x6 a; a# `/ ]  d: x5 A3 Q3 x8 win the fourth quarter.
4 f# x7 a7 i' }% x3 h9 @( l7 UTo 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
# A( h: h* |9 c5 k4 ^. Z1 v& aprovince. Affordability is the key concept behind home
; l9 C0 g- J& ^/ ~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
) {! q$ ^/ d. K5 O8 W- g7 Rof residential construction.
To examine the degree of overbuilding, we employ a
6 ?# s/ C. }4 b- S- r“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* E; \  G# i5 `6 hfundamental-justified level by about 12%. Although new
; X3 e! w0 q" I# Tunits were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
' \! ^" D+ _$ v1 ]4 A) c+ |; kpopulation inflows. Saskatoon, Calgary and Edmonton are
# U" X# ]9 `$ j1 x" H. `- halready witnessing surges in their unsold new homes at the
very time that the resale market has swung into strong
! G' E  q( W9 x1 k  n; nbuyers’ territory. Homebuilding in the Atlantic provinces
0 D/ C4 y) H7 O8 ?) E" {has been relatively balanced but, while not plagued by structural
  E1 e2 W! H  bweakness, will be singed by the downturn nonetheless.
7 P" j5 b6 A! k4 b5 h3 v- C2 `# qQuébec shows signs of strain – especially given the
( l' z- s. J, [+ n8 hstrange accumulation of unabsorbed multiples on l’Île de
3 ^7 j; `: P; W, E+ w7 IMontréal – but recent building has been relatively balanced,
given the province’s history of under-building and low ownership
* ]) K9 l# v: x  E& _# h* {rates. While Ontario homebuilding will reel from a
8 P+ J& c: l+ tcyclical downturn, the degree of structural weakness appears
- W" T* ?' _. `# Z  llimited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
5 [! c. _# F- u* B0 G" E  xconstruction mean that record numbers of condos will
9 v8 ]8 p1 i/ Kreach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
+ E+ L- Z# b0 o) fspike severely – particularly in Vancouver. However, while
) [7 a/ T! y* _1 b5 L! t: D" E: presidential construction in B.C. will definitely droop, we
0 w' Q8 ?* Z$ j( c/ kanticipate that the West Coast will continue to benefit from
inter-provincial and international migration over the coming
. n( j" e- s! \7 Jyears, which, along with improvements in affordability,
% ^8 i9 @. w1 @4 wwill alleviate some of the pressure from overbuilding.
" d6 ^& q6 B. t, b& C* r! u/ iOVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
Pascal Gauthier, Economist
' A$ o: o0 }. l8 L2 a6 f( Y416-944-5730

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

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