TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
from 2002 to 2008, unsustainable price increases drove
unsustainable levels of building. Our view is that house
  Q3 G7 x0 G7 l5 Q3 Pprices exceeded the value of housing that was justified by
% v% M2 x# s8 t+ xfundamentals by approximately 9% nationwide. This
$ [' `5 o$ E6 F+ ~overpricing compelled a level of residential construction
6 Z, @: M: C& T" U5 j6 bthat exceeded its fundamental-justified level by approximately
" |2 p; B+ x, \12%, an excess that was exaggerated in the past
! d* x- c- A- M9 tthree years.
By “overpricing” we mean that prices detached from
( T+ h' @8 K1 D  u1 xtheir fundamentals, as witnessed by a steep erosion of
, c5 q* D: K- Zaffordability. The current unwinding of house prices reflects
3 q' I& \0 |8 J" Pboth a cyclical downturn and a return of house prices
5 y; K/ o4 k# l( dto fundamentally justified levels.
1 }+ a! Q' C* `+ u/ v3 ZWe consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
4 @' q# a7 e7 D7 A( sthat 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
# k. B3 P/ g8 B5 ]“overbuilding” was mainly of the first type, where
4 ^5 D( j1 ^  ^7 x  k+ C1 H0 o, shomebuyers pushed homebuilding to an unsustainable pitch
" N) e! s- g6 k4 p" Gthat is now being rapidly reined in.
5 Y& v9 ~6 b9 x! bWhile most markets won’t face U.S.-style overhangs,
- |7 T& ?8 f4 `) Y: Ethe construction of too many new homes over the boom
means a deepened slump. This overbuilding will likely weigh
! J" g2 O* h1 x( U4 Uon markets over the next few years. Even as Canada recovers
from the cyclical downturn, house price growth will
remain choppy and new residential construction will be
$ M$ [. z2 H8 Wdampened, owing to this structural weakness. Construction
+ r1 q. b) g& F5 eis now undershooting fundamentals and we expect this
1 J/ ]8 f+ V9 \to 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.
" t' X- M+ D! f; H) m) J- UTo quantify the degree of overpricing and overbuilding,
we first develop an empirical model, based on long-run
, Q* d6 m6 l# R. D& I# E3 ^fundamentals 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
% G+ X9 w- j! Z$ R+ `) Z+ C$ \6 x# {/ Eregard housing prices and household formation as the drivers
of residential construction.
To examine the degree of overbuilding, we employ a
- ^2 n# A4 `3 @4 R) v3 f" K“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
- B- u+ p3 |, E' c" doptimally. We find that actual homebuilding exceeded this
) J& }- I( p7 y) n: y/ m8 G9 Dfundamental-justified level by about 12%. Although new
7 x- U) }9 a, Qunits were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
; F( K8 ~# [/ f$ ?' mRegionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
; O; G" R- j6 Z/ a6 w% d6 Palready witnessing surges in their unsold new homes at the
very time that the resale market has swung into strong
- M' M) U  S' Qbuyers’ territory. Homebuilding in the Atlantic provinces
8 G9 b3 E; y/ t0 l/ _1 L9 Fhas been relatively balanced but, while not plagued by structural
( W: G9 Y1 ^( }- c0 r  ^weakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
, L& V$ \' u1 Xstrange accumulation of unabsorbed multiples on l’Île de
5 t* ?( {) ]. U9 m) rMontréal – but recent building has been relatively balanced,
given the province’s history of under-building and low ownership
% B- J3 Q% Q' y+ W. n  z8 }8 E2 e+ ~rates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
5 C+ r8 N" q( b4 f5 vlimited – with the important exception of the Toronto
! ^1 \6 s* [* ~condo market. Both in Toronto and Vancouver, historically
% w* @; T3 B+ T& y$ W, U) V: E3 chigh levels of apartment-style units presently under
6 t: ^  W2 {# \0 {9 D( Tconstruction 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
residential construction in B.C. will definitely droop, we
anticipate that the West Coast will continue to benefit from
0 I! M) p+ A' uinter-provincial and international migration over the coming
& u3 r8 O; r+ d/ H2 Kyears, which, along with improvements in affordability,
' }: r, A6 N+ w( J( Z. _# Jwill alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
: I6 ~! F$ N- C1 L; `3 a416-982-8063
6 `1 Z" l2 |" F% ~1 nPascal Gauthier, Economist
+ G1 |3 A+ S6 g6 L3 O6 I416-944-5730
0 }9 O4 J# w/ j  K6 i4 {; N
http://www.td.com/economics/special/gb0409_housing_exec.pdf

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