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
prices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
- w" |3 j6 y2 K+ B9 yoverpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
three years.
By “overpricing” we mean that prices detached from
; r. h4 E# r1 o% o6 }+ m8 vtheir fundamentals, as witnessed by a steep erosion of
) i8 u1 |6 Z/ J4 s# k5 c1 S4 paffordability. The current unwinding of house prices reflects
both a cyclical downturn and a return of house prices
to fundamentally justified levels.
& T$ }7 P* l& @. [  Q( d/ n0 XWe consider “overbuilding” of two forms: “demanddriven”
  C2 g0 Y: ~& Z! ^where homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
  a# A3 R( T" U' @# uwhere builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
8 V8 }4 Q2 X! r) D“overbuilding” was mainly of the first type, where
5 T9 f: f( Z5 n7 H" F+ Ihomebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
8 ?1 T- g% t6 e! q+ GWhile most markets won’t face U.S.-style overhangs,
the construction of too many new homes over the boom
means a deepened slump. This overbuilding will likely weigh
- G, q( ?: j. h9 w' won markets over the next few years. Even as Canada recovers
7 B; y$ P3 n  v4 C& V: P9 _from the cyclical downturn, house price growth will
remain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
0 J5 G7 L& G2 m. h- hto persist over 2009 to 2011. We anticipate that nationwide
residential construction will fall further to around
; s3 U1 G3 [( n& w/ u125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
To quantify the degree of overpricing and overbuilding,
8 q1 @3 V& g: B5 g2 O/ xwe first develop an empirical model, based on long-run
fundamentals of house prices and housing starts in each
" m  w- N$ F" K7 ^! c4 I: N" o9 ~province. Affordability is the key concept behind home
  Z, P+ w- p7 q  c& `* `- Zvalues since house prices should track incomes over the
! x8 P5 p/ j' l+ l; u& L! A& Hlong-run. Since homebuilders build to meet demand, we
3 Z+ E* P# @& C9 J) g; @5 lregard housing prices and household formation as the drivers
+ t0 B' x) U* @! F2 Iof residential construction.
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
optimally. We find that actual homebuilding exceeded this
- X, X4 X! g% Afundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
  m6 m3 V  D8 e! m9 e& Q8 U. |/ l( Xmany houses at prices that exceeded fundamentals.
1 g: _' b% _; L- F3 cRegionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
5 E1 y" w$ }+ i3 u! Ypopulation inflows. Saskatoon, Calgary and Edmonton are
( m* a% a% J, Q- m' u1 B' `7 ualready witnessing surges in their unsold new homes at the
very time that the resale market has swung into strong
5 e4 T& j* ]  U! X* h9 Jbuyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
" |1 V! N/ u# j, xweakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
9 K7 f5 s  |/ estrange accumulation of unabsorbed multiples on l’Île de
Montréal – but recent building has been relatively balanced,
7 `/ K+ Q9 z2 |* y$ p  Ggiven the province’s history of under-building and low ownership
rates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
  i& D' ?7 L- {2 s2 mlimited – with the important exception of the Toronto
0 d6 p  q$ k( x! e$ k  S# O# z6 jcondo market. Both in Toronto and Vancouver, historically
$ x; {, C# k* m; Mhigh levels of apartment-style units presently under
  H( `0 ?6 a7 Econstruction mean that record numbers of condos will
1 ^8 D, s5 z% ?, S& ~reach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
. q* R. ^- E  _6 _9 _# M7 lspike severely – particularly in Vancouver. However, while
( \- B5 ~4 ^' rresidential construction in B.C. will definitely droop, we
7 B9 N- D( f7 eanticipate 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.
1 x1 t0 _) T: yOVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
6 A# l2 w! n; R8 f2 B416-982-8063
3 K7 U/ E: r" u4 O3 CPascal Gauthier, Economist
416-944-5730

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

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