TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
; f2 I+ s$ }$ rfrom 2002 to 2008, unsustainable price increases drove
unsustainable levels of building. Our view is that house
prices exceeded the value of housing that was justified by
0 K) j: u) m& T0 I$ D5 ~; Xfundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
( }6 f+ W0 `9 C" x) t# O0 ]% ?- X12%, an excess that was exaggerated in the past
three years.
By “overpricing” we mean that prices detached from
1 b# q( k. C1 }# \* G, `/ }; i: G5 {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.
4 t2 S6 d/ U) S. ]2 m4 W% I2 _: `" vWe consider “overbuilding” of two forms: “demanddriven”
6 W, @( Q+ S# M- ?: @) Qwhere homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
- l6 A; d! c% J+ D# @# C2 ?1 a7 kwhere builders accumulate excessive inventories. Although
there 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
4 C* L4 j/ W1 d2 `! y+ i0 Wthat is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
9 H5 c$ K+ Q+ t! c5 d6 L: \the construction of too many new homes over the boom
means a deepened slump. This overbuilding will likely weigh
& l. U% h' o* `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
+ M( w( e! W! d! x( ]9 ~$ B. adampened, owing to this structural weakness. Construction
4 X/ k+ e! ^) ~/ zis now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
: l* h) T- U& j6 l* }: a, ~residential 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,
we first develop an empirical model, based on long-run
' @6 O. ~" t* d" l4 p9 U% i$ zfundamentals of house prices and housing starts in each
province. Affordability is the key concept behind home
8 u' w0 c# e& F$ Uvalues since house prices should track incomes over the
% H! ~; g/ ]. r3 \long-run. Since homebuilders build to meet demand, we
regard housing prices and household formation as the drivers
3 V3 j2 C' F5 C1 ?! Z4 @% ^+ `3 }% qof residential construction.
To examine the degree of overbuilding, we employ a
+ }( a6 ^+ [# t4 D( N6 U5 p“counter-factual,” asking what level of residential construction
: m) n: k4 F" `, n& o# Twould have occurred if housing had been priced
" _2 F+ J* V% Q6 [" coptimally. We find that actual homebuilding exceeded this
8 y$ O& y1 |/ B% n7 ]( gfundamental-justified level by about 12%. Although new
' v" d0 d/ B+ i6 V  Punits 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
population inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
; [' N" n! A4 M2 \8 rvery time that the resale market has swung into strong
! w: y- A; k, I* ibuyers’ territory. Homebuilding in the Atlantic provinces
/ W8 n# \5 X9 ]. p( thas been relatively balanced but, while not plagued by structural
weakness, will be singed by the downturn nonetheless.
' Z' _/ m$ S% \- C, W  Q4 eQuébec shows signs of strain – especially given the
strange accumulation of unabsorbed multiples on l’Île de
+ i# I& f$ Y! ^0 e8 b1 b# k6 D) WMontréal – 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
- Z8 j0 Q6 p0 \+ M  ecyclical downturn, the degree of structural weakness appears
, S0 Q6 J  @, a* R0 V/ P( slimited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
# f3 _8 u' T( iconstruction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
0 R& B: R: h. Aresidential construction in B.C. will definitely droop, we
% F6 d+ X" o+ _anticipate that the West Coast will continue to benefit from
: `) i0 |  M3 ~, s" z( Y' Binter-provincial and international migration over the coming
years, which, along with improvements in affordability,
3 Z& s4 }& [& q; pwill alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
+ J! l7 G5 l9 t# }: {0 mMARKET RETURNS TO FUNDAMENTALS
' E! n- D3 l3 [1 g: lGrant Bishop, Economist
416-982-8063
6 n  f! s" y) }8 c8 ]9 W$ SPascal Gauthier, Economist
( @' @; z3 I( E2 m8 T416-944-5730
" J9 h# C3 }1 ?3 [( n
http://www.td.com/economics/special/gb0409_housing_exec.pdf

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