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
3 G0 E5 M5 G" B$ r& L2 q' ?. ]prices exceeded the value of housing that was justified by
1 w: e. c5 J' X, @1 M( c2 ffundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
/ E2 V& x$ ?2 a% {2 j: r+ C( ethat exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
three years.
) k9 p0 A# H7 x1 cBy “overpricing” we mean that prices detached from
their 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.
, i1 A/ }( ?5 |8 @! `5 L! A7 aWe consider “overbuilding” of two forms: “demanddriven”
" g9 e6 ^% C$ xwhere homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
0 w' z9 P. y# y/ ethere is evidence of both types, we contend that Canada’s
7 w& E6 v, k) u5 d$ K  }/ J: Z“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
+ C; [: `& A$ T7 U0 m$ I  Qthat is now being rapidly reined in.
3 p# [( ?$ T) r1 ]# p4 _$ G; WWhile most markets won’t face U.S.-style overhangs,
the construction of too many new homes over the boom
6 R' Q. ^; \8 _  n1 b/ \4 }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
7 i' X% S7 K2 O9 x* L$ T5 H8 C' Premain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
! C. j8 \* F' @. ~is now undershooting fundamentals and we expect this
3 q/ t9 X; m/ u, E0 B( sto persist over 2009 to 2011. We anticipate that nationwide
9 l- g8 K- y2 nresidential construction will fall further to around
, ~, |( \  _- ^) Z125,000 starts over 2009 with a trough around 115,000 units
' G8 [7 G7 r- d' Win the fourth quarter.
To quantify the degree of overpricing and overbuilding,
we first develop an empirical model, based on long-run
9 E# `7 e2 u& O+ {4 r; R! Efundamentals 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
1 L3 b  P# e4 v0 vlong-run. Since homebuilders build to meet demand, we
/ L6 ]! Y0 |6 w' P4 W8 X1 P/ g! d; j$ cregard housing prices and household formation as the drivers
+ N# V7 v7 a6 o9 Q/ jof residential construction.
$ Z$ P2 n2 C' hTo examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
* V! I4 B* Q( T  mwould have occurred if housing had been priced
! G# D9 h; v* voptimally. We find that actual homebuilding exceeded this
( V9 t( E$ J5 L6 }1 _fundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
; G+ e# K8 H: sRegionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
1 t  R+ ~% y0 |- J! C  upopulation inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
* s  Z/ `* b9 k& Hvery time that the resale market has swung into strong
: O, F, t4 B6 b4 |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.
6 L7 h! W5 U$ e& z3 w+ a, LQuébec shows signs of strain – especially given the
strange accumulation of unabsorbed multiples on l’Île de
Montréal – but recent building has been relatively balanced,
2 D  ~$ U" {) z) E" t$ P8 a# Kgiven the province’s history of under-building and low ownership
rates. While Ontario homebuilding will reel from a
$ X6 l4 M/ h% t) Gcyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
% S  b. J7 w1 O. y3 Gcondo 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
' R8 K: }3 `7 O" acyclical factors would indicate, condo inventories could
( G4 x; M& A, espike severely – particularly in Vancouver. However, while
3 x, T3 J! h* X' i+ kresidential 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
years, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
: f4 W1 z+ p' }* XMARKET RETURNS TO FUNDAMENTALS
( K/ {  U* {9 s, M/ YGrant Bishop, Economist
416-982-8063
# A4 i' y" e! N! v$ iPascal Gauthier, Economist
416-944-5730

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

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