TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
from 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
- T& p3 q+ T# l- f- \8 b1 A6 Qfundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
8 I% h7 I+ j" ]- F* V4 Y; [that exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
three years.
1 ]+ {- f& V+ A& e. RBy “overpricing” we mean that prices detached from
( |# ~! U1 ~" w! itheir 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
, v2 @) n: O: K% |; mto fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
  w" ~. N% K1 N/ {9 R, L( v* V. Fwhere homebuyers buy up too many houses and
$ }, S: f( @- E& }7 Fthat this demand cannot be sustained; and “supply-driven”
( r2 t2 O( ?; qwhere builders accumulate excessive inventories. Although
there 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.
+ F1 k, q) }( t# N" YWhile most markets won’t face U.S.-style overhangs,
) S- [  e4 }  Y: q0 ithe 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
8 w) x; q( H2 G9 }- _9 hremain choppy and new residential construction will be
/ E6 m1 x5 ~  f0 A9 L4 M4 Rdampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
% h! V6 x5 D1 U4 B3 o5 H5 Tresidential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
' I5 H( t. G; v' E6 rin the fourth quarter.
To quantify the degree of overpricing and overbuilding,
we first develop an empirical model, based on long-run
; B7 l# n# i1 O6 j2 e0 w( rfundamentals of house prices and housing starts in each
3 o6 d0 E/ y# Kprovince. Affordability is the key concept behind home
; z: O) \; p  F8 x* j) P5 xvalues since house prices should track incomes over the
0 Z! ?# }7 S2 s* K+ u0 E8 s& u; slong-run. Since homebuilders build to meet demand, we
, t4 e0 y0 D  v+ @7 `8 K8 j/ l0 w3 Cregard housing prices and household formation as the drivers
3 i% `& i. z* X: d9 J; yof residential construction.
) H+ c& H1 O+ dTo examine the degree of overbuilding, we employ a
8 ], k: Y" D/ O0 Y/ v2 U* N“counter-factual,” asking what level of residential construction
: n8 X, h& O0 |4 Zwould have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
7 I: E. j; C" J# y. Z3 W/ C) A5 Munits were being absorbed, homebuyers simply bought too
" @$ |, u: U3 i; j  F1 w: O) Q7 zmany houses at prices that exceeded fundamentals.
8 U7 n3 M5 Z" r/ ]$ bRegionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
9 U5 {( F7 Y- Salready witnessing surges in their unsold new homes at the
1 t! q$ D+ x" {" k% b+ every time that the resale market has swung into strong
; ^: C+ ?5 M* _3 T( M& q* bbuyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
weakness, will be singed by the downturn nonetheless.
. U/ f4 A5 ^, Z; s- r4 S3 H  i9 S6 G: uQuébec shows signs of strain – especially given the
: D, z8 A( `+ ]/ B- Vstrange accumulation of unabsorbed multiples on l’Île de
Montréal – but recent building has been relatively balanced,
given the province’s history of under-building and low ownership
+ Y  x' w) I4 I7 nrates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
2 S! X7 k4 x  ]7 K) Pcondo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
+ Q2 U7 s: W2 Q- ~  r$ ?+ _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
anticipate that the West Coast will continue to benefit from
inter-provincial and international migration over the coming
$ E% R. C. E$ y  q6 g; X  l; {- ?years, which, along with improvements in affordability,
; O2 J  W4 D4 ~' d! `) {. N1 c0 D* R7 Uwill alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
: ~9 d3 d! `8 k5 N  Z+ \416-982-8063
Pascal Gauthier, Economist
416-944-5730

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

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