TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
. ]' e. v; U5 [  b8 Ffrom 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
/ a& Q$ n9 u1 C/ J/ w  l0 Tfundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
/ t; [+ X7 Z3 U! bthat 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
4 i3 I7 ?& o6 k0 D( l1 G4 k( a/ otheir fundamentals, as witnessed by a steep erosion of
: i  s" q, B) e  L# t4 |affordability. The current unwinding of house prices reflects
both a cyclical downturn and a return of house prices
to fundamentally justified levels.
- m5 C' z  Q2 l  X# eWe consider “overbuilding” of two forms: “demanddriven”
$ J$ J0 ]/ `/ y1 awhere homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
: O  q  J* V8 g7 L7 J2 xwhere 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
that is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
5 P: i) x- k4 ~& M: zthe construction of too many new homes over the boom
3 s" `: c- U7 o  Y. a) Lmeans a deepened slump. This overbuilding will likely weigh
. ^+ G  K* t7 i; u; |; bon markets over the next few years. Even as Canada recovers
from the cyclical downturn, house price growth will
- f7 n: ?8 L4 w3 E' mremain choppy and new residential construction will be
: G1 _- d  }( N* N" Fdampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
to 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,
we first develop an empirical model, based on long-run
fundamentals of house prices and housing starts in each
, I. j; r  U: c- J$ U% nprovince. Affordability is the key concept behind home
values since house prices should track incomes over the
' e5 m$ X" e7 T( glong-run. Since homebuilders build to meet demand, we
9 m2 z; J/ G9 [! f, h" a3 mregard housing prices and household formation as the drivers
of residential construction.
To examine the degree of overbuilding, we employ a
) C- h( g- _: F% R“counter-factual,” asking what level of residential construction
2 e$ X! L2 H4 i1 U$ H5 j9 [would have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
9 B) j: _$ E  W7 M4 }# r9 G& J% Imany houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
. [- F% P( r9 {* I" ~1 Hwhere housing demand will further contract under waning
6 Y. U5 K  }+ G. r" r2 i% qpopulation inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
4 L9 t; s! F+ J" M* z. R" Nvery time that the resale market has swung into strong
5 {7 |# s# |& k1 `. }& Q/ rbuyers’ territory. Homebuilding in the Atlantic provinces
2 f# r( F: @, o% Mhas been relatively balanced but, while not plagued by structural
8 Q7 U: ?5 \! X3 |weakness, will be singed by the downturn nonetheless.
$ \8 _" O5 ^" n  s" t+ g+ wQuébec shows signs of strain – especially given the
strange accumulation of unabsorbed multiples on l’Île de
9 o1 Y$ I9 v) e" i8 @9 w/ k: iMontréal – 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
cyclical downturn, the degree of structural weakness appears
9 ]5 `- ~! x  K/ E: e4 z- nlimited – with the important exception of the Toronto
, o  p9 |$ B9 P8 @condo market. Both in Toronto and Vancouver, historically
: S( {9 y, O4 vhigh levels of apartment-style units presently under
construction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
" L9 u2 ?' c8 E0 Ycyclical factors would indicate, condo inventories could
2 v$ z6 S" L) [" g% Aspike 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.
8 e/ X* g1 L: p8 {OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
+ N, i7 }& C0 Y" u% a3 GGrant Bishop, Economist
! V5 L: i5 f/ W( u2 |* c) E( s9 a416-982-8063
, O1 e1 J- `9 I  I$ w( @% ^! KPascal Gauthier, Economist
; M0 o% C6 t& G! R416-944-5730
: T# p" D9 B) ]4 W& K: Q* o! T
http://www.td.com/economics/special/gb0409_housing_exec.pdf

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