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
) d* W" s" b9 _. t3 tunsustainable levels of building. Our view is that house
! N) x' j) A8 Dprices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
8 D" a# m; E2 I0 mthat exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
* Z5 G+ q& A* Kthree years.
By “overpricing” we mean that prices detached from
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.
We consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
9 U# Y; s: f6 L; Ethat this demand cannot be sustained; and “supply-driven”
3 X5 e- \. y6 e+ @1 V* V% w) s. n* _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
# \5 q2 S* U2 V+ x- W6 K8 l/ Ohomebuyers pushed homebuilding to an unsustainable pitch
' e1 s. d4 o- E  l5 a- jthat is now being rapidly reined in.
# I8 k9 j! r, r( v2 Y2 B  z' [; aWhile most markets won’t face U.S.-style overhangs,
the construction of too many new homes over the boom
# X5 B$ l* ~- M/ Ameans a deepened slump. This overbuilding will likely weigh
+ h8 f( Z3 s% K* t3 h* bon markets over the next few years. Even as Canada recovers
from the cyclical downturn, house price growth will
  J5 \4 q3 ^1 y/ V- n+ ?9 C1 Vremain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
  U/ y5 m$ i  d+ Qis now undershooting fundamentals and we expect this
* X( x6 A5 x  m+ |9 ^3 O' Qto persist over 2009 to 2011. We anticipate that nationwide
" m; M( k1 a& }! z# dresidential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
1 c4 w0 ?1 O" C  ~( H0 w: zTo quantify the degree of overpricing and overbuilding,
5 n# v" F0 w$ W" P; A1 }# jwe first develop an empirical model, based on long-run
0 Y4 C: o4 w* a' efundamentals of house prices and housing starts in each
3 q% M" k6 e% ?0 B5 xprovince. Affordability is the key concept behind home
5 K. p& a% d" {8 Svalues since house prices should track incomes over the
long-run. Since homebuilders build to meet demand, we
8 U9 C3 F  Y) @1 G1 a& _regard housing prices and household formation as the drivers
* Y) o1 G: X5 w& Uof residential construction.
To examine the degree of overbuilding, we employ a
' w* j& A1 Z5 O! R7 T1 w“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
' X' o1 M) o( o3 B( p4 doptimally. We find that actual homebuilding exceeded this
1 _) o7 M) D! kfundamental-justified level by about 12%. Although new
* n( m  T9 O0 O  g! funits were being absorbed, homebuyers simply bought too
+ D5 I2 x( W4 d4 pmany houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
! I' ^/ Q( |0 t7 X& d* Nwhere housing demand will further contract under waning
3 u* ^/ G0 E, f# s& {population inflows. Saskatoon, Calgary and Edmonton are
6 g* [# J) Q0 m% {+ b; q9 d2 kalready witnessing surges in their unsold new homes at the
, G3 V5 A8 S9 w. rvery time that the resale market has swung into strong
buyers’ territory. Homebuilding in the Atlantic provinces
9 u  {( W. N- Fhas been relatively balanced but, while not plagued by structural
weakness, will be singed by the downturn nonetheless.
' L! E! d. E& C( |' R+ cQuébec shows signs of strain – especially given the
0 Y% ^: h9 ?8 y' @5 Rstrange accumulation of unabsorbed multiples on l’Île de
Montréal – 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
6 U* d% @: ~& I0 O* k9 |+ mlimited – with the important exception of the Toronto
* K" f0 ], K# ~- O  d+ wcondo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
construction mean that record numbers of condos will
) o. j" S- C7 z5 i( H7 dreach completion during 2009. If absorption rates fall, as
* t6 F9 y' [( R  ]/ h$ J1 Kcyclical factors would indicate, condo inventories could
, p( a5 q' M% a' I2 X4 Pspike severely – particularly in Vancouver. However, while
6 M; ?% N$ i: k8 M$ S8 @* hresidential construction in B.C. will definitely droop, we
3 Y& k) x; H" `( Xanticipate 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.
9 ^$ R& X! O! q& ]OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
3 ]# }- v/ Q6 j9 E* s9 f/ P6 uGrant Bishop, Economist
8 e. K$ W3 A4 c416-982-8063
Pascal Gauthier, Economist
4 l0 {. o5 d( [+ e416-944-5730

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

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