TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
6 q3 H' d, O# ^6 o& B% Hfrom 2002 to 2008, unsustainable price increases drove
unsustainable levels of building. Our view is that house
% F6 \6 o3 V4 ?4 O$ @% Hprices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
: g4 ]& W6 f  [! C: ?1 ioverpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
7 ?. e) t$ `- T( u8 b/ S0 d* h# n12%, an excess that was exaggerated in the past
three years.
By “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
- r- c& h# ?  k0 C  I( C1 L( H( N/ Gaffordability. The current unwinding of house prices reflects
! l/ O3 y2 P5 X  b: W$ vboth a cyclical downturn and a return of house prices
to fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
! k9 g# |4 C& r. W# l- P! l“overbuilding” was mainly of the first type, where
: m% n+ ?9 L# T, C( `2 B5 ~% Nhomebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
/ e3 I2 f5 s6 f2 [: _6 j$ [1 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
on markets over the next few years. Even as Canada recovers
1 ?+ h& t/ L1 Dfrom the cyclical downturn, house price growth will
remain choppy and new residential construction will be
, r, O/ z" o1 L2 \dampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
: Q' j1 w4 z8 @' eto persist over 2009 to 2011. We anticipate that nationwide
0 s# ~- u2 w( T5 |) S: Bresidential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
, b7 o$ q/ d: s& Y4 U/ |. Vin the fourth quarter.
To quantify the degree of overpricing and overbuilding,
we first develop an empirical model, based on long-run
6 W7 R" t+ S- j7 y4 dfundamentals 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
long-run. Since homebuilders build to meet demand, we
7 v) w# w, S" Q: G0 q0 ?regard housing prices and household formation as the drivers
7 ]8 h- P+ c& O2 w, h$ e  F1 iof residential construction.
To examine the degree of overbuilding, we employ a
2 q* x2 l" Y7 F0 N“counter-factual,” asking what level of residential construction
/ [7 m: e7 a5 T. u) l: l0 Twould have occurred if housing had been priced
3 n* y! t" Q5 c% v) ioptimally. We find that actual homebuilding exceeded this
; l/ {1 R8 n3 k2 S: k& Bfundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
, z; K( F! B# nmany houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
6 X# J6 v( k5 f/ A0 d5 ]+ A( `; Swhere housing demand will further contract under waning
- a' H5 a- ?3 |7 r) ~5 Spopulation inflows. Saskatoon, Calgary and Edmonton are
& `6 z$ H$ l  _1 h8 T% C' Ralready witnessing surges in their unsold new homes at the
6 X; p. w2 ?/ D6 R. Svery time that the resale market has swung into strong
buyers’ territory. Homebuilding in the Atlantic provinces
* r  O8 A6 x  Y$ ]: b% r  t- G  T% Zhas been relatively balanced but, while not plagued by structural
weakness, will be singed by the downturn nonetheless.
0 Z7 g( r- ~  b: dQuébec shows signs of strain – especially given the
strange accumulation of unabsorbed multiples on l’Île de
8 D9 |2 W8 E( C' r% \' w  L; r2 VMontréal – but recent building has been relatively balanced,
( s# c+ e/ K* Kgiven 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
$ V' u# f/ h) w% e/ Nlimited – with the important exception of the Toronto
! W& ^: b5 R( X6 @3 K; `condo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
  g$ I; B" u4 |2 Y7 B: a& Nconstruction 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
8 d. q: c( U6 F; X% O/ P4 wresidential 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
. H. {. V- K, I2 B* qyears, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
% }& }* n9 ]* d+ d7 H# XOVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
Pascal Gauthier, Economist
0 j& f& {& g2 H  _: D% A416-944-5730
; B3 p: J- G7 g
http://www.td.com/economics/special/gb0409_housing_exec.pdf

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