TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
5 ~% H! r2 f; B) d. e' rfrom 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
fundamentals by approximately 9% nationwide. This
, C8 h2 z) N# C- Zoverpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
  b4 K* h1 f- B$ l12%, an excess that was exaggerated in the past
' ?0 q9 g' y8 J, \# n; u6 ^three years.
By “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
& Y  z: t  W' _( d+ q  paffordability. The current unwinding of house prices reflects
both a cyclical downturn and a return of house prices
6 y9 `+ P" F9 A% H* Nto fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
, V' @+ d4 j1 x" T# C; C- {3 ethat this demand cannot be sustained; and “supply-driven”
. q- y, U& M: Wwhere builders accumulate excessive inventories. Although
& u0 B- B3 D) b" b, ^there is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
+ T& j3 W9 N: Y+ R; C7 g3 Shomebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
9 x3 b/ J  i+ X9 iWhile most markets won’t face U.S.-style overhangs,
7 e+ O  {: n7 \( g) _3 G5 w8 {: h3 E3 Wthe construction of too many new homes over the boom
- j/ l5 J1 p% B0 S- mmeans a deepened slump. This overbuilding will likely weigh
on markets over the next few years. Even as Canada recovers
& _) {' h3 _3 C8 b1 Qfrom the cyclical downturn, house price growth will
. M' Q) d, V1 G' v  |3 k# yremain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
: w9 P: J3 Z  b# cis now undershooting fundamentals and we expect this
# o- y* O1 d4 O$ z1 L+ eto persist over 2009 to 2011. We anticipate that nationwide
residential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
To quantify the degree of overpricing and overbuilding,
2 l  Q; e) Y1 _( H( m: T' ?% \- Qwe first develop an empirical model, based on long-run
2 R5 ?/ r: U8 F  gfundamentals of house prices and housing starts in each
province. Affordability is the key concept behind home
values since house prices should track incomes over the
9 [$ s0 i1 Z' H3 C5 M( O+ Plong-run. Since homebuilders build to meet demand, we
' ^: Q9 H0 k) `" m6 L$ Vregard housing prices and household formation as the drivers
6 ~% K! p" ?6 d& Y" j0 u7 }of residential construction.
0 \+ h: r. ?* M/ VTo examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
7 |! Y) S% Q% e6 I# N7 V4 g- cwould have occurred if housing had been priced
* a/ @" Q( [( X4 i( r  J2 c6 L$ z" Roptimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
* w% Y0 Y# d, K% ~units were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
6 u4 r0 y) ?$ o  X. q+ URegionally, we see the greatest strains on the Prairies,
( }" g) p& o5 V: Ewhere housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
/ @- T6 l) a4 k: k5 _1 Zvery time that the resale market has swung into strong
, N  F/ |5 n3 C  hbuyers’ territory. Homebuilding in the Atlantic provinces
" p9 g2 {2 j$ m/ Fhas been relatively balanced but, while not plagued by structural
  r- W  Y6 t* m  S5 i# M% F) qweakness, will be singed by the downturn nonetheless.
2 I7 @' D& }1 c# F/ oQuébec shows signs of strain – especially given the
strange accumulation of unabsorbed multiples on l’Île de
# ]; J! I) e, VMontréal – but recent building has been relatively balanced,
given 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
condo market. Both in Toronto and Vancouver, historically
. \: ^2 x+ c/ A! N# v# A8 Ahigh 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
; B, M' d5 l7 ~6 D, kspike severely – particularly in Vancouver. However, while
residential construction in B.C. will definitely droop, we
% X* o& X: K& C" c6 n4 m+ h5 Banticipate that the West Coast will continue to benefit from
inter-provincial and international migration over the coming
years, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
3 K2 Y& E# e4 V1 }MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
8 l+ n! P2 Q0 }8 M, J. O: [% ^Pascal Gauthier, Economist
416-944-5730

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

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