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
: U6 h4 Q9 W" j4 q3 A, \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
overpricing compelled a level of residential construction
$ b# I& z/ b. y5 @$ w% B) |that exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
) _. ~$ X0 c" |( v% }2 V) Y% I; P0 tthree years.
5 \3 S0 d5 u2 E0 F9 s  Q- wBy “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
1 _* X' |" n" r; Kaffordability. 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”
where builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
( F( a6 {- b7 W% B$ J$ s“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
4 V8 }  j# i; i, w3 h0 qthat is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
2 g+ o' n+ l8 V/ rthe 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
) ^1 m. ?% m- Q+ a/ N- F1 r+ mfrom the cyclical downturn, house price growth will
* n- \( d+ h5 |. D, u2 }  ]3 \# T. Wremain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
$ {8 V' N1 n  ^1 n2 C; xis now undershooting fundamentals and we expect this
! v: M" i5 R  vto persist over 2009 to 2011. We anticipate that nationwide
, A% @- q7 T& ^" v5 _residential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
7 J9 L4 x' _+ y* z3 E) |To 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
province. Affordability is the key concept behind home
values since house prices should track incomes over the
' t; x7 \# i/ D" z% r  Ilong-run. Since homebuilders build to meet demand, we
7 s9 G3 v6 x: F% B' P: M' dregard 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
: y( A4 a2 w8 E9 }$ gwould have occurred if housing had been priced
/ s' I# ?4 u1 K- k1 x! V* }optimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
+ e5 P. T( H( j+ o6 e2 vpopulation 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
: i8 v7 u' F9 S$ sbuyers’ territory. Homebuilding in the Atlantic provinces
1 k6 o) G. P5 {+ T7 Ohas been relatively balanced but, while not plagued by structural
: M( J6 h% D! e) l" k* nweakness, will be singed by the downturn nonetheless.
8 |" S7 ?/ e7 q/ f2 g9 VQuébec shows signs of strain – especially given the
; `: c; z) b7 ~$ \# fstrange 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
! n3 B' c9 B0 w5 wrates. While Ontario homebuilding will reel from a
# {, I4 u; g% T* z9 E* d5 Q- p" [cyclical downturn, the degree of structural weakness appears
. z9 T( m( C0 l6 C6 G" {limited – with the important exception of the Toronto
5 n3 F6 h" g# jcondo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
% V- [& X! K$ f$ d& D6 @) H' bconstruction mean that record numbers of condos will
$ T! U8 O8 {6 S: M5 O% _# Areach completion during 2009. If absorption rates fall, as
. O5 q0 b7 w2 E/ I5 E. B8 D" Wcyclical factors would indicate, condo inventories could
/ e/ z) h  ^: ]" m' X9 @! Pspike 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
years, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
8 ]* I3 M$ P. f' T3 e! @3 V. LMARKET RETURNS TO FUNDAMENTALS
1 Q. l- A3 r* y& CGrant Bishop, Economist
416-982-8063
4 i5 ?7 Q2 I' qPascal Gauthier, Economist
416-944-5730

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

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