TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
6 d4 j$ R3 ~; f# J0 Dfrom 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
: @  [9 W  _6 f9 p8 E2 M- {- Vfundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
& }2 F* ^8 [' }- P' t* X& I  r% ythat exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
three years.
: o0 @& g0 v1 YBy “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
9 O, `" G, r5 X' W; d9 d. x. T! Kto fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
0 u" k. j) h- X3 Hwhere homebuyers buy up too many houses and
% r6 C. S9 J" H7 M6 \+ Pthat this demand cannot be sustained; and “supply-driven”
9 y' N# G5 l: z6 X4 r* u  ?+ jwhere builders accumulate excessive inventories. Although
; L* u1 e$ Y  h6 [; gthere is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
+ i! {. {! d& V& nhomebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
  x9 N" `  m$ Q) x) q2 E6 EWhile most markets won’t face U.S.-style overhangs,
the construction of too many new homes over the boom
means a deepened slump. This overbuilding will likely weigh
! Z0 h, k# Z* z0 k' m# ^on markets over the next few years. Even as Canada recovers
! O/ K( N' u6 t8 bfrom the cyclical downturn, house price growth will
9 |" k5 D8 `" y" R' \remain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
$ y  ^" h( Y6 I1 p9 Y: i9 z& N" W: Hto persist over 2009 to 2011. We anticipate that nationwide
residential construction will fall further to around
( B4 h# _7 Y' ^+ {9 \1 j" H125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
# v- \1 M; E4 w6 c+ VTo quantify the degree of overpricing and overbuilding,
2 B9 p8 b, l5 e; kwe first develop an empirical model, based on long-run
fundamentals of house prices and housing starts in each
! W; j( d! e1 N' H! hprovince. Affordability is the key concept behind home
. b# }( _, ~9 ~, o1 Vvalues 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
+ {+ b% D" w& g9 o' ?/ eof residential construction.
: ^7 x1 v9 p$ z- RTo examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
9 ~! {0 q8 v" n$ ]/ Z+ j' rwould have occurred if housing had been priced
! Q. f+ E; q* U7 C. L" R" Doptimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
5 D' d8 ?. Y- L. E" A) c: f; Bunits were being absorbed, homebuyers simply bought too
; b* x: ?4 x* umany houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
- U' Y) r9 o7 tpopulation 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
buyers’ territory. Homebuilding in the Atlantic provinces
" Y# G& \& G; Yhas been relatively balanced but, while not plagued by structural
' D/ d0 r  s1 Q( X( k3 |weakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
strange accumulation of unabsorbed multiples on l’Île de
) N* |# }. y; P* h' ?: {3 @8 s; i8 y5 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
# Y+ S" ~; `# l0 {; e& d3 Hcyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
- _+ C. j6 S# ^, c: ^7 ^* R2 [high levels of apartment-style units presently under
construction mean that record numbers of condos will
1 @% T3 m% d$ [- areach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
' w* A$ x! f: ]; k  Uspike severely – particularly in Vancouver. However, while
, E# N, A3 ~" T4 s7 Tresidential construction in B.C. will definitely droop, we
anticipate 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
4 {# \% m- i$ m& x" r8 aMARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
Pascal Gauthier, Economist
416-944-5730

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

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