TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
7 ?, Q7 D' L: i, sfrom 2002 to 2008, unsustainable price increases drove
. n, P7 T+ o! H7 v4 |' Q2 G" M* \unsustainable levels of building. Our view is that house
; @! Q  i. {, ]9 Z) }4 ]prices exceeded the value of housing that was justified by
+ A! j! @! k6 L  Sfundamentals by approximately 9% nationwide. This
8 C* I7 G! @6 k% coverpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
three years.
2 F$ U& r7 H( }/ I! ]) t  jBy “overpricing” we mean that prices detached from
% B, D2 z: ~( q9 J  K: T. }: htheir 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”
" _9 a: |+ ^2 _% }' m) Zwhere builders accumulate excessive inventories. Although
. V8 k$ m! z5 j* ]6 d5 Sthere 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.
While most markets won’t face U.S.-style overhangs,
the construction of too many new homes over the boom
' Q) A1 Z% W' }# p0 Rmeans 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
remain choppy and new residential construction will be
3 _9 M* `* H$ F( N- ^dampened, owing to this structural weakness. Construction
# K! ?& ~2 s! n7 |5 zis now undershooting fundamentals and we expect this
" a) v7 _3 v0 `to persist over 2009 to 2011. We anticipate that nationwide
4 e0 \( e  l, N$ n7 sresidential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
' v  [2 u) `' K. x/ h) BTo 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
& J2 g4 i: p4 F) z2 sprovince. Affordability is the key concept behind home
5 l9 X9 r8 g/ j- N# vvalues since house prices should track incomes over the
long-run. Since homebuilders build to meet demand, we
3 D  k; B( f; m5 ?! q" C/ Wregard 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
would have occurred if housing had been priced
% [8 N5 Z- R. e* \; w3 x6 Ioptimally. We find that actual homebuilding exceeded this
# \1 y2 S. T% g5 X/ B" S/ `fundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
8 A9 V- d: z( p/ |' f% Q4 q2 mmany houses at prices that exceeded fundamentals.
& ?% r9 a1 u" U5 ~% ?Regionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
" X7 u! n! j0 e' Ppopulation inflows. Saskatoon, Calgary and Edmonton are
' v: x" K* Y, m/ x9 |already witnessing surges in their unsold new homes at the
/ ^; o8 Q3 n  V/ Xvery time that the resale market has swung into strong
buyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
weakness, will be singed by the downturn nonetheless.
8 R7 u  j* `* Z7 }4 i& D* aQuébec shows signs of strain – especially given the
strange accumulation of unabsorbed multiples on l’Île de
Montréal – but recent building has been relatively balanced,
given the province’s history of under-building and low ownership
rates. While Ontario homebuilding will reel from a
8 {8 _9 g" ?' l. j5 R3 x4 l& Ucyclical 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
cyclical factors would indicate, condo inventories could
) z6 B0 G* R5 d5 [% P( Z7 ^6 cspike severely – particularly in Vancouver. However, while
residential construction in B.C. will definitely droop, we
$ `2 o+ c4 W8 m% K7 hanticipate that the West Coast will continue to benefit from
inter-provincial and international migration over the coming
4 G$ ~+ D4 R3 {years, which, along with improvements in affordability,
, l8 f3 C. y# g) M7 y7 J. s! d5 [7 X, d" Bwill alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
! V% L0 G; N, _/ L, y8 g$ E7 JGrant Bishop, Economist
416-982-8063
9 ?" P0 d* p; _  S9 w3 RPascal Gauthier, Economist
416-944-5730
  A* w' J1 x; Z% h6 P6 s# ^0 R
http://www.td.com/economics/special/gb0409_housing_exec.pdf

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