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
prices exceeded the value of housing that was justified by
0 z- a* [# r7 L: c; A5 i7 f* pfundamentals by approximately 9% nationwide. This
# ?' s* z7 V2 `$ {6 ]( Doverpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
; J4 W7 T% x/ T9 N12%, an excess that was exaggerated in the past
* W! s2 S- r& u2 qthree years.
By “overpricing” we mean that prices detached from
# W& N) e5 m& m! O0 y/ k, l- ytheir 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
to 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”
5 j. V) Q8 [8 rwhere builders accumulate excessive inventories. Although
- \5 Z9 u9 r9 G9 m$ x- F7 v3 {: ]there is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
1 H0 \, J8 |! ]2 c% TWhile most markets won’t face U.S.-style overhangs,
8 \: C$ F& g9 P1 F  f) D0 c. ~* Pthe construction of too many new homes over the boom
means a deepened slump. This overbuilding will likely weigh
0 B# Q. E1 c% k/ C; ^' ^6 fon markets over the next few years. Even as Canada recovers
  Y* g& |! e( w9 m- w5 n# Sfrom the cyclical downturn, house price growth will
7 M* r4 n( N( E/ Mremain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
2 Z$ W$ P# |" C) s) lis now undershooting fundamentals and we expect this
% l  Y" H" A6 k% Q# t) \9 Z7 ~to persist over 2009 to 2011. We anticipate that nationwide
; a4 f% ^3 V6 S& _0 N5 oresidential construction will fall further to around
  f7 ?) e% r: y; E125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
, n& F" k0 j. e( P' \; ]* h/ i: \' u( YTo 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
& n9 e& T  p. Q6 Tprovince. Affordability is the key concept behind home
values since house prices should track incomes over the
- g! |  V2 R9 f) U1 O4 ulong-run. Since homebuilders build to meet demand, we
) F# z) D7 S! }: W2 V9 h" eregard housing prices and household formation as the drivers
of residential construction.
* k- l: S" l; h- ?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
4 j2 Q2 I' q  t6 H# Y0 @' goptimally. We find that actual homebuilding exceeded this
* N. u9 X% u+ t+ X5 vfundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
2 g2 X2 i" n, t3 F7 `Regionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
' a6 X- h4 N8 Q" Zpopulation inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
very time that the resale market has swung into strong
! `$ @# m) q: U: S: L" X/ dbuyers’ territory. Homebuilding in the Atlantic provinces
- ~$ }  ?$ u! y; w( p3 _has been relatively balanced but, while not plagued by structural
' G% L* T2 ]% K; uweakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
strange accumulation of unabsorbed multiples on l’Île de
4 M7 H' e& k; ]/ F7 S" cMontréal – but recent building has been relatively balanced,
given the province’s history of under-building and low ownership
5 u( [# I1 T: J3 ^rates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
! b% l- N: A+ H; n" Ilimited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
, ?0 I/ G- |; T: Q6 g$ Wconstruction mean that record numbers of condos will
$ G4 g5 v- |) {( oreach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
6 @  J0 R9 ]: y; W* i! ]  }( yspike 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
inter-provincial and international migration over the coming
) I. e3 e5 z, K6 y( y4 M$ W* Iyears, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
4 T$ E4 `- S$ j# J' i( nOVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
0 t& w. k! n: z, bPascal Gauthier, Economist
416-944-5730
* N, m- K" W/ h( X( _& s
http://www.td.com/economics/special/gb0409_housing_exec.pdf

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