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
1 }7 ?" b4 R- P& R1 qunsustainable levels of building. Our view is that house
/ Z( u5 p( }. [0 @prices exceeded the value of housing that was justified by
" H6 L7 |& W' n% Q  C. vfundamentals by approximately 9% nationwide. This
) ~$ Y9 r0 N" O$ Z0 {, P$ ^' eoverpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
0 W1 [3 E  _/ @, Z0 K4 [: o- Nthree years.
By “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
9 b/ H% O! S: X4 Xaffordability. The current unwinding of house prices reflects
2 l! w4 ?7 h% a' m& A# E; oboth a cyclical downturn and a return of house prices
4 n% |6 ~8 f9 i" t: sto fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
& H! r% S9 P4 w+ c6 M( S: N( k1 Lwhere homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
' m% e- n# ]$ k4 Qthere is evidence of both types, we contend that Canada’s
# G& i/ r3 b: l& Y& R  s9 f“overbuilding” was mainly of the first type, where
: I9 s3 X2 |( t4 E  x0 S4 d9 w0 g! ]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
5 t+ [* A# D, g  j9 X' @# E' wmeans a deepened slump. This overbuilding will likely weigh
on markets over the next few years. Even as Canada recovers
# I/ H' A0 t4 ~' E1 u! q# Kfrom the cyclical downturn, house price growth will
remain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
. n- F; A, @9 a, P$ ~, j$ dis now undershooting fundamentals and we expect this
- q, ~+ p  _: E% ^7 h  Lto persist over 2009 to 2011. We anticipate that nationwide
% I6 m: |  x7 |8 r: Zresidential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
To quantify the degree of overpricing and overbuilding,
0 y4 a0 u! A6 ~" w/ ~% \we first develop an empirical model, based on long-run
; T' C; p3 [( s/ Dfundamentals 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
long-run. Since homebuilders build to meet demand, we
regard 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
, M4 a9 D" k. O8 B! w+ Twould have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
* x# I! c: s  ?/ E: Ufundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
, Q0 |! y! y2 lmany houses at prices that exceeded fundamentals.
- `7 C! ~5 l: z& xRegionally, we see the greatest strains on the Prairies,
8 @' Q/ _* O7 Mwhere housing demand will further contract under waning
; p' F7 y" V' g% [1 a2 jpopulation inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
5 {+ P$ ~/ H  every time that the resale market has swung into strong
buyers’ territory. Homebuilding in the Atlantic provinces
* ?/ `$ o% p1 I7 |" ^. ^has been relatively balanced but, while not plagued by structural
weakness, will be singed by the downturn nonetheless.
8 B* Z, o( O1 U- J/ A$ p  V0 GQuébec shows signs of strain – especially given the
7 b' j9 u, e" u5 e, S  cstrange accumulation of unabsorbed multiples on l’Île de
Montréal – but recent building has been relatively balanced,
3 a' _! p  i3 Z4 b3 ?( sgiven the province’s history of under-building and low ownership
# M& d  u8 p0 `6 a' R; ]( Hrates. While Ontario homebuilding will reel from a
7 c: C6 K& Z* B+ y* {" mcyclical downturn, the degree of structural weakness appears
5 S/ k' U+ C; vlimited – with the important exception of the Toronto
# e+ n$ f/ ^3 z9 q" M9 Y( C6 L6 Zcondo market. Both in Toronto and Vancouver, historically
* Z6 a& d9 m$ l2 L) u& ^# ihigh levels of apartment-style units presently under
construction mean that record numbers of condos will
$ n/ l: n; }; |6 _% R/ }7 F- ?reach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
! V/ n) F, D) gresidential construction in B.C. will definitely droop, we
anticipate that the West Coast will continue to benefit from
: s. p- G! g. V0 binter-provincial and international migration over the coming
/ l3 r+ y/ ]" {3 {: X3 f6 Pyears, which, along with improvements in affordability,
6 j, w3 w, Z* e. `0 Swill alleviate some of the pressure from overbuilding.
. z/ M& j& h$ I6 M9 T: }2 t7 EOVERPRICED AND OVERBUILT: CANADIAN HOUSING
) E5 G& e7 `( @! zMARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
% z5 y3 X, L8 D) Z, b$ A416-982-8063
Pascal Gauthier, Economist
4 [0 z+ j2 _( c/ l416-944-5730

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

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