TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
" R, j' |$ S2 ^& k8 }from 2002 to 2008, unsustainable price increases drove
unsustainable levels of building. Our view is that house
0 o6 l* e9 U# y  R: |* M" ?prices exceeded the value of housing that was justified by
' Y, H/ G8 r' H( k( P- }4 N3 `fundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
/ B0 [+ I+ O# P1 n- i) lthat exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
& l" b  G. p$ P9 X$ S; w2 T' zthree years.
By “overpricing” we mean that prices detached from
. N4 j) C* O* P$ H* l0 R6 rtheir fundamentals, as witnessed by a steep erosion of
7 R9 q4 c/ K, ^9 a7 ~/ U0 uaffordability. The current unwinding of house prices reflects
both a cyclical downturn and a return of house prices
to fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
- h" d% m3 h% M! r0 q* Y* T' kwhere homebuyers buy up too many houses and
# [% I+ v) i5 Z& Y* W5 `2 R. I1 Ythat this demand cannot be sustained; and “supply-driven”
9 h0 {1 l* `1 x- J! Twhere builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
/ Z5 u- [$ s8 n( O! l# ahomebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
% s7 B* m7 w) h+ B9 z, l9 ~While most markets won’t face U.S.-style overhangs,
+ V! Z* H' t2 Y, dthe 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
2 p+ I- Q) B! O) P+ u: ]4 Jfrom the cyclical downturn, house price growth will
7 b  U& c; e. i( \remain choppy and new residential construction will be
# K/ }! E5 J& R( Ldampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
9 \  \& T8 s/ ?, U3 W! U$ @8 _to 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,
we first develop an empirical model, based on long-run
fundamentals 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
& J9 i: U7 \" v! ^1 ^& ?5 K: w( u2 nlong-run. Since homebuilders build to meet demand, we
regard housing prices and household formation as the drivers
of residential construction.
" Q. M/ r) }) {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
/ Y1 Z9 a1 O& Q2 M& [5 xoptimally. We find that actual homebuilding exceeded this
+ v! b  M* l6 Y$ J4 ~fundamental-justified level by about 12%. Although new
2 }* Z6 b$ h+ O8 aunits were being absorbed, homebuyers simply bought too
% Y% |2 V8 x* imany houses at prices that exceeded fundamentals.
2 B5 c9 G0 h7 lRegionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
7 W! z, U8 O8 ^, F- t  \/ R$ [population inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
) T9 H3 i) X% I% D+ X+ ]2 nvery time that the resale market has swung into strong
; P  t: a5 ~& Y7 ~" y8 m9 s- b: Abuyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
( U! W, M  {2 i+ n6 p0 j9 B/ w5 pweakness, will be singed by the downturn nonetheless.
. f4 Y6 G, L' @: o, `Québec shows signs of strain – especially given the
& {; r. B/ x# L2 V: w* qstrange accumulation of unabsorbed multiples on l’Île de
# V- S7 _; [8 c( A4 \! G( E6 Q  n+ JMontréal – but recent building has been relatively balanced,
given the province’s history of under-building and low ownership
: w4 P8 n) `  trates. While Ontario homebuilding will reel from a
& L- e' D; e7 R8 [4 p! ]  Fcyclical 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
construction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
residential construction in B.C. will definitely droop, we
! k! h  {: s4 [$ ~7 q; Y5 vanticipate that the West Coast will continue to benefit from
inter-provincial and international migration over the coming
4 ~  u3 K4 I) r  _! z% Pyears, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
3 A1 q) e) \- f$ ^MARKET RETURNS TO FUNDAMENTALS
2 ?$ d, X0 A& R. l4 B- C1 pGrant Bishop, Economist
416-982-8063
Pascal Gauthier, Economist
% h4 |4 l  W) G- N2 K7 g4 A- j416-944-5730

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

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