TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
" i8 G  y. r' j) ~8 j- T& yfrom 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
overpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
- z3 j2 ?, J6 O, `+ _7 `2 w( s* i12%, an excess that was exaggerated in the past
three years.
+ x% j" A( }# F+ J) fBy “overpricing” we mean that prices detached from
+ L1 @% b( E6 [their fundamentals, as witnessed by a steep erosion of
# I6 A3 w  O/ h" @9 n4 O- G/ Raffordability. The current unwinding of house prices reflects
" `0 e* @3 V& J* h" z/ Aboth a cyclical downturn and a return of house prices
/ B, A' p1 v$ ?- B! rto 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”
/ ]2 b( j( D: @. G8 s, Ewhere builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
  o9 W- U& ?" F( A) _“overbuilding” was mainly of the first type, where
( C8 `; _9 d" C5 s$ u+ t" |) P5 P# Whomebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
  u* k9 P, `3 ~* v' F/ ~6 qWhile most markets won’t face U.S.-style overhangs,
( Q, A) d0 `' l% I+ F' j1 a7 Athe 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 d6 x$ i, I, p- Xfrom the cyclical downturn, house price growth will
0 r3 Y5 A1 y/ m) h% H: Dremain choppy and new residential construction will be
4 m, q& M3 `% T) j# ]: x/ x1 I1 ?dampened, owing to this structural weakness. Construction
8 ?6 j; c. n0 `0 |/ t5 Eis now undershooting fundamentals and we expect this
5 H6 T1 X( y8 o" i- B* Nto 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,
. Z' m# ]0 b1 M( \- l! S8 w+ X( ^  lwe first develop an empirical model, based on long-run
5 }6 t2 |5 e* Hfundamentals 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
regard housing prices and household formation as the drivers
( E4 [7 f+ q; r8 ^# G+ hof 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
1 G! ^/ p& w9 r5 eoptimally. We find that actual homebuilding exceeded this
8 O9 U- A8 Q) [  B2 v5 F& O+ @fundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
4 @( p# v* ^( L3 F0 B2 {& vRegionally, we see the greatest strains on the Prairies,
) H% o- }5 w% k) N% `: X% j# ^where housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
/ i0 _0 ?0 u) a: s5 talready 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
* j5 ~6 H" d$ B' q, x$ W7 U% U- Cweakness, will be singed by the downturn nonetheless.
. c0 |, g. `+ o7 fQuébec shows signs of strain – especially given the
8 H! _1 [7 F. p. {! ostrange accumulation of unabsorbed multiples on l’Île de
* T* J( z; c' {5 `3 A/ a. G; nMontréal – but recent building has been relatively balanced,
given the province’s history of under-building and low ownership
rates. While Ontario homebuilding will reel from a
+ \: Z! S& b9 Lcyclical downturn, the degree of structural weakness appears
% o+ C3 g3 n( V! `. J) ~limited – with the important exception of the Toronto
8 ~9 A1 P; X: t) v; L+ kcondo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
% B% i- T/ }& O8 T! g: U" [construction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
$ x7 _$ j7 C7 i' vcyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
/ ?8 V" |% ~  _4 h# Uresidential construction in B.C. will definitely droop, we
9 a. X$ }  u, k6 C% Y; t* k% kanticipate that the West Coast will continue to benefit from
( a9 O  A2 K  v  ainter-provincial and international migration over the coming
years, which, along with improvements in affordability,
$ y& D! X7 ?0 N' m: k/ C* C8 o4 Twill alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
' e5 U' ^5 q  B8 z% hMARKET RETURNS TO FUNDAMENTALS
' Z# H3 U. K6 \5 i+ s# bGrant Bishop, Economist
  D% P( x# O0 H; y9 G9 Q416-982-8063
. T3 C/ \& ~4 e3 h' RPascal Gauthier, Economist
416-944-5730
# J$ W0 N: b' U. M0 D3 y- ]
http://www.td.com/economics/special/gb0409_housing_exec.pdf

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