TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
# G2 \6 T. `2 {" i1 z( Lfrom 2002 to 2008, unsustainable price increases drove
4 X& U0 w, Z/ E! |" z( Gunsustainable levels of building. Our view is that house
) d2 i2 c" n- g, N+ V  ?prices exceeded the value of housing that was justified by
, i5 z; |  o9 U# i5 f8 v" |fundamentals by approximately 9% nationwide. This
) s' l* i7 A: n2 `9 |" n' Joverpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
% A( T3 ]: k+ Bthree years.
  x/ N! @' O, |* VBy “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
  }0 W* s1 Y6 E/ M0 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”
where builders accumulate excessive inventories. Although
/ b. r- V4 J+ A/ o& ^9 A( jthere is evidence of both types, we contend that Canada’s
5 `" j$ G4 t2 s& S“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
7 Z; q. [4 a# O5 E' O: C& B" s; `that is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
the construction of too many new homes over the boom
! X  n( s  Y( ?+ x  Wmeans a deepened slump. This overbuilding will likely weigh
- D1 l0 A: \0 }, q; y0 t$ Ton markets over the next few years. Even as Canada recovers
- D) e  R" y6 }; I' U: t1 v- A/ tfrom the cyclical downturn, house price growth will
, V! W" ^" O6 r, Iremain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
0 J! X5 s0 Q+ t: K( q6 k- Bis now undershooting fundamentals and we expect this
3 l% k' M# j4 p! A9 L3 `" i! bto 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.
+ B* Z  U# U* M2 @5 VTo 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
province. Affordability is the key concept behind home
- U; D7 ]/ ^; B5 uvalues since house prices should track incomes over the
6 N5 g/ R2 g' i7 \7 R- K- s% u2 Flong-run. Since homebuilders build to meet demand, we
+ n8 l% `; P& h7 q) [regard housing prices and household formation as the drivers
of residential construction.
To examine the degree of overbuilding, we employ a
. Y9 w: M- Y! G- Z2 v4 Z: y- u  {' `“counter-factual,” asking what level of residential construction
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
many houses at prices that exceeded fundamentals.
$ T6 }. x. C, BRegionally, we see the greatest strains on the Prairies,
( z# h1 e. y. n/ G9 L% bwhere housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
7 P2 W) P" _& m# P$ \# M; salready witnessing surges in their unsold new homes at the
very time that the resale market has swung into strong
/ K$ e# U3 d5 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
1 e) U: p2 t; u: Hstrange accumulation of unabsorbed multiples on l’Île de
& y" V6 }! g1 j/ T/ mMontréal – 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
9 G$ v" ?: O) X3 I4 ~cyclical downturn, the degree of structural weakness appears
' P7 c+ v  {3 R" y- _% alimited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
% {: _  B6 ]) b* f( F, oconstruction mean that record numbers of condos will
4 f5 h6 G% x% w; ^9 B1 D+ d5 K: ~reach completion during 2009. If absorption rates fall, as
; ^8 S! B. |4 k: G4 Qcyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
/ ]. f' b& S- Oresidential construction in B.C. will definitely droop, we
anticipate that the West Coast will continue to benefit from
; c% V) b  O9 ~8 a5 h4 A- K* yinter-provincial and international migration over the coming
& P: H; |; M* c, x7 iyears, which, along with improvements in affordability,
2 K" l4 Z& [. E* O; cwill alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
Pascal Gauthier, Economist
. A9 c' A% y0 s416-944-5730

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

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