TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
* K$ E+ I0 ]" H- Sfrom 2002 to 2008, unsustainable price increases drove
unsustainable levels of building. Our view is that house
, I! B: t" I& U! e9 h: B2 t+ wprices exceeded the value of housing that was justified by
! w. I- g9 y) D) e1 `! v. ]6 H. qfundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
3 K# O4 C+ T  ]5 }that exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
three years.
+ F4 O+ B4 s1 j+ Z  P) gBy “overpricing” we mean that prices detached from
4 {/ y7 Q5 \& V4 C  \their fundamentals, as witnessed by a steep erosion of
0 I1 C9 g! x6 ]2 Aaffordability. The current unwinding of house prices reflects
. W( I+ E, ]) o, n9 \7 R  [both a cyclical downturn and a return of house prices
7 C1 s1 w* }' ?to fundamentally justified levels.
$ G7 Z1 N+ F* c' N6 p* OWe consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
/ |6 ]/ h6 W8 s6 ^% b$ Q. F% M8 h% }that this demand cannot be sustained; and “supply-driven”
& D' u) g4 P: Y9 mwhere builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
/ l- K# y0 g# A! W0 G2 e“overbuilding” was mainly of the first type, where
! Y/ z3 R5 O* k* chomebuyers pushed homebuilding to an unsustainable pitch
that 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
  @+ I4 d6 @( `5 h$ M9 J- Jmeans a deepened slump. This overbuilding will likely weigh
6 b. @  d2 {+ Z8 K: Jon markets over the next few years. Even as Canada recovers
from the cyclical downturn, house price growth will
3 a% c7 F3 `8 }( {remain choppy and new residential construction will be
) Z  E2 G$ j! ^+ L7 l' w4 m* ndampened, owing to this structural weakness. Construction
0 m9 W3 s: O& q1 Tis now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
residential construction will fall further to around
+ o2 g; b5 J! Q) Y9 ~, F125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
To quantify the degree of overpricing and overbuilding,
4 _% s- [, ~& e$ R2 p8 s. awe first develop an empirical model, based on long-run
8 F, T# ]  m- n5 q& |fundamentals of house prices and housing starts in each
province. Affordability is the key concept behind home
  c, w) e3 L3 m9 ^* S8 _$ ^values since house prices should track incomes over the
) X9 R# u& O4 {1 q  v  ilong-run. Since homebuilders build to meet demand, we
, W, }6 Q- e0 X" `0 Hregard housing prices and household formation as the drivers
5 ?9 f( Z  _* Z+ j5 j- gof residential construction.
! G1 y4 U( G4 |) {- [% jTo examine the degree of overbuilding, we employ a
- u8 B4 j3 `; J* q“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
3 R3 ]' V' G: X9 l: b( ounits were being absorbed, homebuyers simply bought too
/ Z0 b( k/ x$ `' n  b1 p/ R  Tmany houses at prices that exceeded fundamentals.
/ ~. O1 V' I+ a& I' x# E5 [9 j2 bRegionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
% h4 a4 y; [2 }already witnessing surges in their unsold new homes at the
3 Q' V& u, E% Ivery time that the resale market has swung into strong
5 c4 ^! y. d4 z1 l" a/ e+ q6 {+ i# E8 vbuyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
) ]: @/ M) T  A) l( Q% kweakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
strange accumulation of unabsorbed multiples on l’Île de
1 \% @2 l1 e3 N$ c1 _Montréal – but recent building has been relatively balanced,
! x' ]. t  r5 k/ R3 H# G! b9 s) ?given the province’s history of under-building and low ownership
8 ?& Y* w! d- A5 V6 G, T8 Z* |rates. While Ontario homebuilding will reel from a
) d/ q# O9 ]/ B& acyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
construction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
" i: x7 b, ^5 L  }" g% Acyclical factors would indicate, condo inventories could
& C7 A2 T  q; C1 e! dspike severely – particularly in Vancouver. However, while
residential construction in B.C. will definitely droop, we
4 \7 V$ M  _* ^% i/ Janticipate that the West Coast will continue to benefit from
( q. T5 a, i; ~. R" Pinter-provincial and international migration over the coming
years, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
+ o) j8 p: J8 T/ F% ~0 M1 O2 V) \OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
& A# [8 b( W% i8 \8 l3 E& TGrant 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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