TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
4 @5 h5 j4 J, G- Q& pfrom 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
fundamentals by approximately 9% nationwide. This
2 [# B0 n, u8 y" ?4 }5 ooverpricing compelled a level of residential construction
- C/ j9 W3 A4 G9 T* Sthat exceeded its fundamental-justified level by approximately
9 t1 l& w  f8 X/ y+ |4 f12%, an excess that was exaggerated in the past
three years.
; u( x' s8 A+ E: x$ a8 P1 ZBy “overpricing” we mean that prices detached from
8 a5 ^& W  P  {# htheir fundamentals, as witnessed by a steep erosion of
% x: l4 Z9 ^) [4 B7 V) w0 gaffordability. The current unwinding of house prices reflects
both a cyclical downturn and a return of house prices
1 ^! s- S* V1 x3 o( F/ p, Q  D( Bto 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”
) }1 z6 N9 @" C# N0 S) swhere builders accumulate excessive inventories. Although
$ k1 t) D9 P' Y  h6 J. Xthere is evidence of both types, we contend that Canada’s
! Q1 h+ J0 _# C$ Z! U3 l“overbuilding” was mainly of the first type, where
; x' Z& E. j) M5 q7 Y6 rhomebuyers pushed homebuilding to an unsustainable pitch
8 w5 E$ o- ]+ [9 w0 m+ ~- vthat is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
1 E& W" Q2 T* i, dthe construction of too many new homes over the boom
means a deepened slump. This overbuilding will likely weigh
+ F, o( W$ ~2 o; u+ Ton 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
' Y3 d" i5 S- s) ]" T8 E0 i$ J/ adampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
, q: [  j% w, j+ vto persist over 2009 to 2011. We anticipate that nationwide
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,
( o6 g' e- U: O  Ewe first develop an empirical model, based on long-run
fundamentals of house prices and housing starts in each
0 u! k, }* X) oprovince. Affordability is the key concept behind home
9 R7 u* c5 i, M' f7 i+ h; lvalues 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
5 d! y8 j* {0 l; uof residential construction.
$ N$ K) Y$ A, g7 ~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
  W; `2 m7 g  [" I/ Goptimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
- |7 x* K/ h8 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,
& u) G2 Y6 L- f' _" f& R8 j$ p9 y. [2 Q$ Wwhere housing demand will further contract under waning
8 ?9 L9 }0 P8 }9 C3 V# ^$ B# spopulation inflows. Saskatoon, Calgary and Edmonton are
- u; k1 I3 D8 D- D; \already witnessing surges in their unsold new homes at the
1 E) ]+ W) L$ R/ ?" b( Zvery time that the resale market has swung into strong
6 Z( a1 _* W4 J( l' M# `1 A/ wbuyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
weakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
strange accumulation of unabsorbed multiples on l’Île de
Montréal – but recent building has been relatively balanced,
/ M: d" w7 \1 h, o5 `& v# xgiven the province’s history of under-building and low ownership
$ e& U; z5 `+ w' B; c, Vrates. While Ontario homebuilding will reel from a
; t: S% K4 V  T" ~# F" A& ~cyclical downturn, the degree of structural weakness appears
; `  E% I6 H$ w/ f+ Z9 C9 ilimited – 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
spike severely – particularly in Vancouver. However, while
residential construction in B.C. will definitely droop, we
$ x% ~; E: p  i5 u9 i  r% Qanticipate that the West Coast will continue to benefit from
inter-provincial and international migration over the coming
years, which, along with improvements in affordability,
; I: _. j0 n' t8 e; zwill alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
; y) f! j, ]' K9 U: {! c/ DGrant Bishop, Economist
: R- l, I3 u$ l( b' h, i6 J7 b416-982-8063
& |0 _1 u& d! j: v* y8 U$ TPascal Gauthier, Economist
416-944-5730
' y1 I- j+ m; O/ t. Q
http://www.td.com/economics/special/gb0409_housing_exec.pdf

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