TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
& T* Y! [/ O2 v  I, j4 i4 T% nfrom 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
; ]# X2 I; ~1 Z, s8 [' p" Soverpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
% R3 m0 ^' p0 g2 a+ D" Dthree years.
By “overpricing” we mean that prices detached from
/ q- Z8 E! Z8 i; X$ S" Ntheir fundamentals, as witnessed by a steep erosion of
1 e) n; M3 b, ]- g6 oaffordability. The current unwinding of house prices reflects
both a cyclical downturn and a return of house prices
$ j' s7 \! T! |to fundamentally justified levels.
* w; z9 g8 |% A6 N' dWe consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
1 Y. M) W& ?; d( ewhere builders accumulate excessive inventories. Although
/ A7 H5 ]. ], M1 gthere 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,
5 l2 c: O& t' }* `, V  ethe 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
from the cyclical downturn, house price growth will
" [1 f$ s. h$ R! y: Y' M& e. Rremain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
) r$ ^( Y, u% u7 kresidential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
0 T! j) {9 |* O* x% T8 Q/ _8 f5 lTo quantify the degree of overpricing and overbuilding,
6 L9 M/ e3 e7 e/ r8 H# Lwe first develop an empirical model, based on long-run
' ^! b/ t7 r. Q5 K. B5 v$ i' j( Wfundamentals of house prices and housing starts in each
2 Q% Y+ Z8 r6 e/ U+ Rprovince. Affordability is the key concept behind home
* _% P4 t) Q2 X4 t" X$ C9 Uvalues 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
of residential construction.
To examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
: @" V0 [! ~) ^: Zoptimally. We find that actual homebuilding exceeded this
; `1 J  c0 {$ O  p+ w$ S' m0 sfundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
; m& P- ^3 B/ c# j7 R; ]+ Y4 hmany houses at prices that exceeded fundamentals.
/ m& w, K/ L3 Y' u- I" wRegionally, we see the greatest strains on the Prairies,
4 m- E  c* ]9 R( E+ Q8 G( T7 y1 Xwhere housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
) V% T& m7 P; X. z  ?2 qalready 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
has been relatively balanced but, while not plagued by structural
- t6 r- q0 G7 }; b. bweakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
strange accumulation of unabsorbed multiples on l’Île de
/ @4 K( F7 c9 VMontréal – but recent building has been relatively balanced,
+ O& J) D. x* T/ H# O4 I$ y0 t+ Dgiven the province’s history of under-building and low ownership
rates. While Ontario homebuilding will reel from a
( R9 V- W: S( c5 H2 U4 A/ tcyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
" q+ S; w) h& M( ?construction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
1 O6 C' J6 k) _/ d; N' l. g2 bcyclical factors would indicate, condo inventories could
$ O: @* A+ Z6 q' C. s) }2 d8 _5 j% cspike severely – particularly in Vancouver. However, while
residential construction in B.C. will definitely droop, we
. `" B6 M0 N; [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,
* ?; @1 @! v6 D) ?9 s7 cwill alleviate some of the pressure from overbuilding.
5 m& p1 T/ ~3 B; ~OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
3 X. L, g+ P- r2 e$ Y# {Grant Bishop, Economist
3 Z; T  O- X" I6 D416-982-8063
Pascal Gauthier, Economist
416-944-5730

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

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