TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
: U# |; V& B$ p& N5 r0 Kfrom 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
2 A- x; k, S$ F2 b; k! yoverpricing compelled a level of residential construction
! y9 a3 P0 A: x8 B" r' rthat exceeded its fundamental-justified level by approximately
, \& {+ ~- e& g3 U' k2 g12%, an excess that was exaggerated in the past
three years.
By “overpricing” we mean that prices detached from
3 c+ i/ y% T. ?& Ntheir fundamentals, as witnessed by a steep erosion of
( ~; o0 F; V+ n, p1 c, ^3 {  y0 baffordability. The current unwinding of house prices reflects
both a cyclical downturn and a return of house prices
to fundamentally justified levels.
" p( v7 o, z9 L. O" v7 S3 I9 V0 oWe consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
' U9 r& e' M6 Q; }5 |/ C6 f) ithat this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
* ~0 k5 B. C! w  N$ Xthere is evidence of both types, we contend that Canada’s
# w( B. \& y, P# \! O. q6 |/ [“overbuilding” was mainly of the first type, where
, L: p6 J- V  `: l: uhomebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
5 E4 \6 k. \1 ~& g  C5 \/ ~the construction of too many new homes over the boom
8 N8 U! i/ z$ @9 omeans a deepened slump. This overbuilding will likely weigh
on markets over the next few years. Even as Canada recovers
5 ?( R6 a/ ?; Z  ^- Y/ sfrom the cyclical downturn, house price growth will
remain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
( `( I) ~9 y) ^: w! V% @% Iis now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
! P$ f$ f/ r7 p$ r9 h8 ?4 _residential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
$ n# c* f4 p" \7 ^. X; ^4 {+ hin the fourth quarter.
; w/ A# z8 R1 V. M  B5 }To quantify the degree of overpricing and overbuilding,
9 j, I7 y& S, l2 Vwe first develop an empirical model, based on long-run
' U% t2 E( C+ s/ `6 _fundamentals of house prices and housing starts in each
province. Affordability is the key concept behind home
$ s/ W$ P  s' l/ X: D$ L4 `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
of residential construction.
To examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
# K8 @# S; [2 C4 G0 b( a+ O( a  swould have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
2 |/ ?2 p: @" D' ]4 N! p$ Xunits were being absorbed, homebuyers simply bought too
9 Q+ y# k5 K* r  [& U  Nmany houses at prices that exceeded fundamentals.
2 q% h1 X9 u. T  T' Y$ ^Regionally, we see the greatest strains on the Prairies,
+ a; p' ?4 `, r  [2 ]where housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
$ d0 Z, k& B7 h7 Q# w( galready witnessing surges in their unsold new homes at the
very time that the resale market has swung into strong
8 T% J3 B; y9 u2 Lbuyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
weakness, will be singed by the downturn nonetheless.
; J  n6 k/ T: sQuébec shows signs of strain – especially given the
strange accumulation of unabsorbed multiples on l’Île de
2 n% v( c4 H! b9 Z" i$ t4 ?; iMontréal – but recent building has been relatively balanced,
2 w6 P9 i( X# w( x' x9 O/ }given the province’s history of under-building and low ownership
" |$ X7 e6 L9 W! |- v, M+ D% Crates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
7 d' u! K' |1 i: S" v& jlimited – with the important exception of the Toronto
. W4 s& j! N- _% j* J, {condo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
  H& k+ `: n! ^construction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
; @$ T& P# `6 d/ J3 n+ p2 {spike severely – particularly in Vancouver. However, while
, B7 f* }7 t  N9 N% ~2 uresidential construction in B.C. will definitely droop, we
! V8 l% o8 i6 w" ]. w, hanticipate that the West Coast will continue to benefit from
. ]" l) v) S$ P) V" K/ `inter-provincial and international migration over the coming
- D; h( t8 @" D" d: y5 oyears, which, along with improvements in affordability,
- E1 i( g% C# `2 m! v- W* `will alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
6 h9 J$ {: Q4 w8 Y' N  pGrant Bishop, Economist
# d& w3 ~& ?, ^6 x+ c1 ~& U, R5 N416-982-8063
Pascal Gauthier, Economist
8 |# Q" y/ Q9 u416-944-5730

http://www.td.com/economics/special/gb0409_housing_exec.pdf

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