TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
$ {4 f9 p) V$ N9 ~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
, L$ ^7 s3 ?5 {: j/ {& Zfundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
9 r6 S" O; X! ^6 O  ~that exceeded its fundamental-justified level by approximately
  m  r" {1 ]4 d- q12%, an excess that was exaggerated in the past
three years.
By “overpricing” we mean that prices detached from
0 ^  P8 M, x; L, V- Z$ Rtheir 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
! D4 J  Q/ g4 {( H, {/ Kto fundamentally justified levels.
3 J1 }2 E$ F0 J* cWe consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
' y, k/ ]9 ~5 j8 athat this demand cannot be sustained; and “supply-driven”
6 E) H8 U/ b! ]4 rwhere builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
+ R3 \% v2 f/ J“overbuilding” was mainly of the first type, where
& b) X& r7 S$ t6 L2 Y/ M8 ^homebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
' q" v8 w& H! U8 o9 KWhile most markets won’t face U.S.-style overhangs,
the construction of too many new homes over the boom
! S3 t7 K6 D4 ]means a deepened slump. This overbuilding will likely weigh
on markets over the next few years. Even as Canada recovers
) z, N% M# y6 K" \+ cfrom the cyclical downturn, house price growth will
remain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
4 F( o- v9 G5 B$ h9 @is now undershooting fundamentals and we expect this
& x' R% O; F( ^5 R8 X  g) oto 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.
$ h  E3 d: B" O3 S" B, K. y/ kTo 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
' e8 w! A' h6 y- _( d7 N, zprovince. 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
3 w- F, }9 u) ]" Hof residential construction.
( H+ @8 h+ c# \To examine the degree of overbuilding, we employ a
0 d, t6 n4 A  A* k“counter-factual,” asking what level of residential construction
, k* g8 i* m1 G5 Owould have occurred if housing had been priced
+ g6 u1 ~4 |, X- B! n5 O' C* ooptimally. We find that actual homebuilding exceeded this
$ J* D) l" g! D) O# z2 U' ]; u; D3 ?fundamental-justified level by about 12%. Although new
) L2 V; r% u0 y$ D7 funits were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
/ z7 I7 D. c, Y+ talready witnessing surges in their unsold new homes at the
very time that the resale market has swung into strong
- U, h4 }6 L9 P  K, g3 j! zbuyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
weakness, will be singed by the downturn nonetheless.
# h/ p" M5 C: ]# k2 T7 yQuébec shows signs of strain – especially given the
1 Z! \0 a2 V& W: \" P9 j, k3 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
: v( Q! }/ K" V  Lrates. While Ontario homebuilding will reel from a
, L  ]# p0 f  K- I# I' x" o# Ucyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
% X3 `; d, |/ _$ x9 O6 x8 Mhigh 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
5 x9 _+ T# `$ L) r# e! sspike 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
, ]/ ]4 {& l: k& f% B/ I6 tinter-provincial and international migration over the coming
years, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
- v7 Y% j9 S6 MOVERPRICED AND OVERBUILT: CANADIAN HOUSING
3 V0 ]  J5 Q2 G8 RMARKET RETURNS TO FUNDAMENTALS
: J' h4 S8 M9 _- _% iGrant Bishop, Economist
( D4 k& P3 T5 `# V1 {, d) U/ I4 ]416-982-8063
Pascal Gauthier, Economist
" j+ f0 F. e5 J( s4 p416-944-5730
( P) p, C8 p/ T! |* G( l  q1 s; f! J8 n
http://www.td.com/economics/special/gb0409_housing_exec.pdf

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