TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
- G+ l; y8 u9 Mfrom 2002 to 2008, unsustainable price increases drove
" R" i/ A& {- g; t7 x) iunsustainable levels of building. Our view is that house
+ W% h$ D: L0 Aprices exceeded the value of housing that was justified by
. m0 A0 W$ \. J, k1 }' xfundamentals by approximately 9% nationwide. This
. R. K; j3 R6 I9 \9 Poverpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
, s# z' z% m1 {# f8 J3 W12%, an excess that was exaggerated in the past
three years.
By “overpricing” we mean that prices detached from
: B: h, ]# ~& r1 \& `8 Q* {their fundamentals, as witnessed by a steep erosion of
6 i9 n) R. D- `: w9 U3 z  Yaffordability. The current unwinding of house prices reflects
both a cyclical downturn and a return of house prices
% C9 t# s( Y0 X1 L" o3 {to fundamentally justified levels.
4 G2 q1 B/ J) V; u& I/ \1 `We consider “overbuilding” of two forms: “demanddriven”
; Y- o' E! l- ]7 g9 owhere homebuyers buy up too many houses and
+ K3 y, G0 G) C. |) `' ^+ \that this demand cannot be sustained; and “supply-driven”
$ g/ A( X8 e; q$ d6 D+ ?% t: rwhere builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
& `- @7 ~; P2 Y  ^$ |0 u7 d“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
; F4 H7 H0 Q8 Y" othat is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
the construction of too many new homes over the boom
- b3 E4 [$ u& a- ?, E2 ^( vmeans a deepened slump. This overbuilding will likely weigh
$ f( f6 c7 v: @. kon markets over the next few years. Even as Canada recovers
from the cyclical downturn, house price growth will
! N! h* e0 c8 ^2 r" i  Qremain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
* X0 `; T0 w" T% Ato persist over 2009 to 2011. We anticipate that nationwide
, V- X  H+ P/ d* \& m% fresidential construction will fall further to around
6 V; h7 w8 R0 v8 ?. a( K* G2 Z125,000 starts over 2009 with a trough around 115,000 units
  ^: F# a' H; k% f8 N* v. b4 [6 Yin 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
! d  O4 A2 ?2 x! J( B/ Uvalues since house prices should track incomes over the
: y) a6 A+ `5 D# y  B8 Mlong-run. Since homebuilders build to meet demand, we
regard housing prices and household formation as the drivers
( F9 w  m0 b7 i( o+ p, |of residential construction.
) [3 k6 K7 d' V/ n' GTo examine the degree of overbuilding, we employ a
" n: ^, M" E# n( C+ P“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
) _- T  M, l0 i+ m* J1 @8 `optimally. We find that actual homebuilding exceeded this
  F. n  Z6 C4 Pfundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
/ R; |0 G) S! _4 r# b4 R# s; ywhere housing demand will further contract under waning
3 }1 y! H; y5 _, ~3 Y# O5 S6 Kpopulation inflows. Saskatoon, Calgary and Edmonton are
+ _4 ~, K# P2 A" {' H( n# yalready witnessing surges in their unsold new homes at the
3 Z# W' x5 I$ Z( [5 O& ivery time that the resale market has swung into strong
9 V9 Z1 b1 y6 m/ t& T/ P# [buyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
weakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
  K2 Q& ^$ Z$ t/ Mstrange 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
2 W& `. R3 Y4 ~8 M1 Vrates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
/ L/ _' w  `  X; o* Pcondo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
, G" L: N9 h5 @construction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
/ _+ j4 X% _0 E$ K6 ]  j3 D' b! fcyclical factors would indicate, condo inventories could
$ X0 F$ {* J- M- ]8 y4 Aspike 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
' C/ P- t. F$ a8 binter-provincial and international migration over the coming
years, which, along with improvements in affordability,
3 A4 s! h: ?; x: t- @will alleviate some of the pressure from overbuilding.
( `( X) B) b- q9 u4 NOVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
& R9 k1 @9 V/ ]* X! \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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