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
2 `2 Q5 \' S' L, k( |unsustainable levels of building. Our view is that house
$ w3 _0 n2 s4 ]* l- s$ Yprices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
% }9 F8 ]$ z: m/ G' E; Koverpricing compelled a level of residential construction
* e& L7 ~2 Q6 Q" h: Lthat exceeded its fundamental-justified level by approximately
6 E9 s7 x: _: j& ]; U12%, an excess that was exaggerated in the past
three years.
3 b  W( g, [2 p. a6 B7 C- PBy “overpricing” we mean that prices detached from
% p6 @3 ?  I0 O' q. I( ttheir fundamentals, as witnessed by a steep erosion of
" a. B% s5 U" f4 b  T* p4 f6 paffordability. 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”
, W6 K+ z% B& Y% G4 bwhere 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
8 ?+ ~# P' l% E- c5 A. E: U0 {homebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
6 \( {0 y: K+ J6 Q3 F0 nthe 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
from the cyclical downturn, house price growth will
% p! Q# a) `1 c( Sremain choppy and new residential construction will be
8 q; M' U1 M9 z  B7 ~# L/ gdampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
) v) ?4 E, V0 K8 yto persist over 2009 to 2011. We anticipate that nationwide
residential construction will fall further to around
3 r9 b" ~$ H" j4 U4 w- l125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
& L2 R. B/ a. b  p1 T. K5 Y# oTo quantify the degree of overpricing and overbuilding,
3 L) Q! n. V4 |9 k9 f5 U1 wwe first develop an empirical model, based on long-run
, i. N% l6 E5 g$ _. d' B6 \9 j9 _fundamentals of house prices and housing starts in each
province. Affordability is the key concept behind home
; o5 w3 [+ J) [& }) ~' W7 E5 _2 fvalues since house prices should track incomes over the
5 a& k% M8 i! a) Klong-run. Since homebuilders build to meet demand, we
regard housing prices and household formation as the drivers
of residential construction.
2 r, G, a% Y4 E  y9 Q# U# iTo examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
- d4 J* P& \* V& L* E$ p) Goptimally. We find that actual homebuilding exceeded this
% ?# f; ]7 @- t: q! w, z0 Q8 Lfundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
" s( o0 p: c, s$ V, T! d1 ?4 Jmany houses at prices that exceeded fundamentals.
, Y! n5 @3 V1 v, e3 W- FRegionally, we see the greatest strains on the Prairies,
! C( i  p7 F7 n' e# owhere housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
* b# W# ~& P5 ~; p6 m! K# g. {already witnessing surges in their unsold new homes at the
very time that the resale market has swung into strong
% ?5 s8 ^1 u, K3 Y8 L1 \buyers’ territory. Homebuilding in the Atlantic provinces
$ s1 o2 F6 I  {) o# k4 h- ohas been relatively balanced but, while not plagued by structural
weakness, will be singed by the downturn nonetheless.
3 \- |! d5 O: |9 @; y& gQuébec shows signs of strain – especially given the
strange accumulation of unabsorbed multiples on l’Île de
Montréal – but recent building has been relatively balanced,
* v% ]1 }" S! d' `+ lgiven the province’s history of under-building and low ownership
( k+ X, Q# ?3 ?& urates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
construction mean that record numbers of condos will
/ n$ e# e  H3 t7 R% z6 Oreach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
' m, Z$ m$ ~' K% B) G3 |; V; \spike severely – particularly in Vancouver. However, while
( w, j8 c: J1 {) T7 G9 C* n/ Vresidential construction in B.C. will definitely droop, we
+ z3 N) _& _) B" H% r7 wanticipate that the West Coast will continue to benefit from
: L, S4 m) v5 \. {/ d0 k0 r: Qinter-provincial and international migration over the coming
years, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
  H& M2 ~( T# s2 W! l# nOVERPRICED AND OVERBUILT: CANADIAN HOUSING
  c" ]: A9 I( H: g  V1 {MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
- U* W$ U* n' ~416-982-8063
5 n1 f7 E5 m1 ^7 D+ @Pascal Gauthier, Economist
416-944-5730

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

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