TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
$ y, M1 D- R7 \3 R  ?3 s' J9 ^5 kfrom 2002 to 2008, unsustainable price increases drove
unsustainable levels of building. Our view is that house
& Y2 a0 S6 u8 tprices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
0 ^& H/ o! I$ athat exceeded its fundamental-justified level by approximately
6 H3 c1 }* P6 D+ h$ b: L12%, an excess that was exaggerated in the past
three years.
, O5 K5 L- M/ J% {" E3 R7 U8 JBy “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
/ \( ]9 w! F* [0 x8 O6 K2 ^both a cyclical downturn and a return of house prices
4 H: e( {! Y* M+ kto fundamentally justified levels.
; L3 a: l6 ~% Y& T  i" vWe consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
  o6 F1 f0 a6 a) @  ]there is evidence of both types, we contend that Canada’s
( c8 z: s. X" p( f. i" @# w! }! E“overbuilding” was mainly of the first type, where
& L, i2 e0 w+ j1 G* Yhomebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
the construction of too many new homes over the boom
$ O7 W) I5 n; e4 s% c3 i: Fmeans a deepened slump. This overbuilding will likely weigh
$ D- u9 E$ o2 f& q5 qon markets over the next few years. Even as Canada recovers
# D$ F6 {( a& W5 U# v2 Ofrom the cyclical downturn, house price growth will
" I2 i, U: C6 V# D# Kremain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
0 G1 j$ }4 J1 Z3 X. j( |  |is now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
. v( v3 w3 z" o4 Z) k8 |% n  uresidential construction will fall further to around
! i/ l9 q! J" z; h6 S( d125,000 starts over 2009 with a trough around 115,000 units
5 l  F2 s# t9 y% d( Uin the fourth quarter.
2 a5 G& W5 C* HTo quantify the degree of overpricing and overbuilding,
we first develop an empirical model, based on long-run
7 G, f. h5 ^. pfundamentals of house prices and housing starts in each
province. Affordability is the key concept behind home
4 \- W9 E* k8 j0 R9 \8 [; _values since house prices should track incomes over the
4 ]; N% ?8 O9 z- h* i" ]long-run. Since homebuilders build to meet demand, we
regard housing prices and household formation as the drivers
of residential construction.
6 |! b4 X' W/ e5 Q% nTo examine the degree of overbuilding, we employ a
  [8 c9 B1 n" @9 B5 u“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
, g+ F/ j( `5 o7 s) @7 j" M, ~3 Toptimally. We find that actual homebuilding exceeded this
9 T' y. o  |  S1 l# P4 Bfundamental-justified level by about 12%. Although new
, V8 d/ _/ y$ N# H4 xunits were being absorbed, homebuyers simply bought too
5 g3 j3 Z+ m9 Jmany houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
very time that the resale market has swung into strong
- E! |  W4 I# o! _5 {buyers’ territory. Homebuilding in the Atlantic provinces
2 z) h8 |. \5 n4 Q* O3 ohas been relatively balanced but, while not plagued by structural
weakness, will be singed by the downturn nonetheless.
' N: y2 R1 [' ^2 r- g+ ?- e0 IQuébec shows signs of strain – especially given the
strange accumulation of unabsorbed multiples on l’Île de
Montréal – but recent building has been relatively balanced,
( ~* ]' s' ]5 h- M7 Jgiven 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
limited – with the important exception of the Toronto
6 N% n. C  G% n! P6 Zcondo market. Both in Toronto and Vancouver, historically
6 M) W1 A5 i; Ghigh levels of apartment-style units presently under
9 `0 ]" ], m5 T' s' Mconstruction mean that record numbers of condos will
* Y1 Q. k' ^0 t4 ]  x- E; `; R* Creach completion during 2009. If absorption rates fall, as
! W  }  }6 F, @2 \% d1 _7 v$ vcyclical factors would indicate, condo inventories could
9 h, m- {) G" K& uspike severely – particularly in Vancouver. However, while
  i) `  E8 `& Mresidential construction in B.C. will definitely droop, we
6 D3 g% v. q! b$ Eanticipate that the West Coast will continue to benefit from
inter-provincial and international migration over the coming
years, which, along with improvements in affordability,
! V1 j7 B3 t! Q7 t% @* |will alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
% w( V# B' P% e4 F. GMARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
( p) a/ H5 F6 m9 ~/ \416-982-8063
2 N$ X3 |& @' u- m( O$ mPascal Gauthier, Economist
9 v7 O. i# B  U) V( x416-944-5730

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

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