TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
# a# j1 m+ {( Z6 w# afrom 2002 to 2008, unsustainable price increases drove
unsustainable levels of building. Our view is that house
( C% T6 D$ {, J$ e( r$ iprices exceeded the value of housing that was justified by
2 a/ E7 ^$ E, @; R& V+ b4 j' Efundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
  E6 @1 D9 k5 D) |5 rthat exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
three years.
By “overpricing” we mean that prices detached from
9 _7 m0 |& ~: q& b+ \their fundamentals, as witnessed by a steep erosion of
9 s- {5 h+ f+ v3 b; B! [, i% taffordability. The current unwinding of house prices reflects
0 G- f" v% E8 }6 z& Cboth a cyclical downturn and a return of house prices
to fundamentally justified levels.
- b! @8 X1 u1 D( }We consider “overbuilding” of two forms: “demanddriven”
: \' ]% a7 K; W4 J7 y$ mwhere homebuyers buy up too many houses and
. ^2 @3 y: j8 L, {' I% x- q1 |1 ?that this demand cannot be sustained; and “supply-driven”
; J4 A' W% ~8 gwhere builders accumulate excessive inventories. Although
' |, y# G& s5 p, N0 e5 Uthere 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
: A! d$ h: i( {- [that is now being rapidly reined in.
) g% f, O; A7 [# b! T5 W# R  TWhile most markets won’t face U.S.-style overhangs,
the construction of too many new homes over the boom
means a deepened slump. This overbuilding will likely weigh
on markets over the next few years. Even as Canada recovers
from the cyclical downturn, house price growth will
) F8 Q1 ~) R0 c# o. w5 ~remain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
! I3 e+ S9 m- n% M0 r: Ito persist over 2009 to 2011. We anticipate that nationwide
6 K: `! _' l5 l" Rresidential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
( \1 e$ a1 N( X  `( w1 ], ?4 @in the fourth quarter.
To quantify the degree of overpricing and overbuilding,
we first develop an empirical model, based on long-run
' c$ u5 A4 Q! ?fundamentals of house prices and housing starts in each
province. Affordability is the key concept behind home
; J( |4 e( P# n9 x! \9 O: Avalues since house prices should track incomes over the
long-run. Since homebuilders build to meet demand, we
! c. S6 G; U% s+ X1 P( wregard housing prices and household formation as the drivers
of residential construction.
# ?/ z/ x$ g$ N; p4 ITo examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
: [3 \. e# J5 k/ Owould have occurred if housing had been priced
: z9 R+ i) @: Z% v  r) Uoptimally. We find that actual homebuilding exceeded this
1 x$ l7 A* {9 O7 i# E8 u, g2 y, h1 gfundamental-justified level by about 12%. Although new
. U7 j1 W# e' R# z6 [% Wunits were being absorbed, homebuyers simply bought too
3 }. t  K# _3 O7 _4 _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
  h$ u# K1 g. I2 @already witnessing surges in their unsold new homes at the
5 M- m) ~' b1 J/ q# a) v2 t, Nvery time that the resale market has swung into strong
buyers’ territory. Homebuilding in the Atlantic provinces
. o: k' F; m) ?1 Z" F: L% `has been relatively balanced but, while not plagued by structural
weakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
' [0 T; n& F) n& R8 Estrange accumulation of unabsorbed multiples on l’Île de
Montréal – but recent building has been relatively balanced,
5 u" {# b0 r1 j% K8 i: Egiven the province’s history of under-building and low ownership
rates. While Ontario homebuilding will reel from a
cyclical 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
6 r& t! D/ o0 X( ocyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
) X6 d, d( A9 N; H3 n& l, Oresidential construction in B.C. will definitely droop, we
, o6 v! T' |) d) Z$ B- Manticipate that the West Coast will continue to benefit from
inter-provincial and international migration over the coming
years, which, along with improvements in affordability,
$ M( `3 E/ C9 b1 z' `, e6 ]will alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
0 N) i0 p8 s# }* gGrant Bishop, Economist
416-982-8063
6 W$ v* @8 J) E2 U1 oPascal Gauthier, Economist
1 ~+ q1 J2 S/ D416-944-5730
9 R! g: k1 Z* Y* G* D+ k
http://www.td.com/economics/special/gb0409_housing_exec.pdf

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