TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
6 F# b6 c# a: a" Dfrom 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
1 C# c6 N" k* |+ b+ @fundamentals by approximately 9% nationwide. This
0 [& @; y! ~* x% boverpricing 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
5 I7 Z6 z; m, Ltheir fundamentals, as witnessed by a steep erosion of
& R: i+ J, b6 Aaffordability. The current unwinding of house prices reflects
+ `3 x, N8 [2 I/ _both a cyclical downturn and a return of house prices
to fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
8 o3 k3 G# u$ d3 C2 qwhere homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
/ M/ I! Q" o. W; r4 p# p3 khomebuyers pushed homebuilding to an unsustainable pitch
! b; D. V2 ~* R  Q6 Ethat is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
1 }5 t7 D4 w  tthe construction of too many new homes over the boom
means a deepened slump. This overbuilding will likely weigh
on markets over the next few years. Even as Canada recovers
3 ^3 j& S2 Q. b$ n5 zfrom the cyclical downturn, house price growth will
remain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
: l4 s7 G* t5 P7 V. kis 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
5 ?1 @  G7 U# a$ Lprovince. Affordability is the key concept behind home
' ?0 z; A1 B. P# evalues since house prices should track incomes over the
4 s" L% X3 b+ qlong-run. Since homebuilders build to meet demand, we
* {# Q! r5 l) ?3 aregard housing prices and household formation as the drivers
+ N! W4 k8 r: K3 Z0 pof residential construction.
To examine the degree of overbuilding, we employ a
8 T+ H4 C: R8 a/ N+ [“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
5 t0 X0 @1 n# z% L6 o+ J/ uoptimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
/ G, l$ o0 }# G- {% T% Wmany houses at prices that exceeded fundamentals.
9 f0 t" {! z, _+ sRegionally, 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
) c2 Z6 ]- R0 X* Gvery time that the resale market has swung into strong
buyers’ territory. Homebuilding in the Atlantic provinces
7 T. D* W+ |/ e8 K! B+ Thas 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
7 q) \2 {" g% b. w% ?. r( |" ~, Fstrange accumulation of unabsorbed multiples on l’Île de
3 {' o0 G0 P7 r+ r  e  \Montréal – but recent building has been relatively balanced,
& G' L6 B5 o8 {0 x: o4 e/ k, Ngiven the province’s history of under-building and low ownership
rates. While Ontario homebuilding will reel from a
  M. E  b# _! @cyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
& L$ W+ \/ A* z9 r+ tcondo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
5 R7 R* d3 ^3 M! sconstruction mean that record numbers of condos will
4 m) q: y" h5 c% G7 g- hreach completion during 2009. If absorption rates fall, as
, ^. z2 }7 y! ~& Wcyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
7 s7 l+ j& b" c4 e& }/ z( Yresidential construction in B.C. will definitely droop, we
' ^2 v8 B) W0 M# `: P& C- l+ ganticipate that the West Coast will continue to benefit from
* r( z0 k: k: ?+ y/ J. pinter-provincial and international migration over the coming
years, which, along with improvements in affordability,
, i$ m) R: U0 N3 r/ fwill alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
) U0 J; F. ?$ U& s$ q& nPascal Gauthier, Economist
416-944-5730
7 J$ _  \2 A3 a' C5 g" w" Y9 n3 E2 f. r
http://www.td.com/economics/special/gb0409_housing_exec.pdf

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