TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
, \3 c4 Z% F4 f! H% t9 Kfrom 2002 to 2008, unsustainable price increases drove
& t. v* |9 V  k2 J6 B4 ~unsustainable levels of building. Our view is that house
prices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
0 ?8 W: d+ R) k8 a$ P# D$ aoverpricing compelled a level of residential construction
5 l6 n* @9 u% L. `3 ythat exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
6 L- T- a8 s, o1 m7 t1 y: zthree years.
9 |5 y& n7 o- a1 _By “overpricing” we mean that prices detached from
% t, j. F/ g. M- M4 U* E3 Ytheir fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
. [6 {; }; S1 b2 |- V/ Wboth a cyclical downturn and a return of house prices
- P" ^3 H( `- x3 Uto fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
5 e" p# `  G, b. hthat this demand cannot be sustained; and “supply-driven”
7 b* l3 E( ]" lwhere builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
& E, v# x# }4 R/ x- ghomebuyers pushed homebuilding to an unsustainable pitch
5 k5 Z2 {7 D  Sthat 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
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
( d0 `/ D9 G! H8 |" Rremain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
9 r; n8 F( f- b) {; Y3 P# Nresidential 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,
- e. C; ?0 r) e/ P9 x% E4 xwe first develop an empirical model, based on long-run
6 m5 f- b4 E. ]9 U& cfundamentals of house prices and housing starts in each
province. Affordability is the key concept behind home
values since house prices should track incomes over the
8 j, Z9 L8 p* u& j8 Dlong-run. Since homebuilders build to meet demand, we
* N" h$ I5 \+ i. b/ uregard housing prices and household formation as the drivers
1 o" x5 Y7 c5 E3 N/ gof residential construction.
To examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
# [! e# ^6 l+ m. s  X# Ywould have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
( p3 ~4 [( l/ I; l! Bfundamental-justified level by about 12%. Although new
& l- _) p; G) T: wunits were being absorbed, homebuyers simply bought too
: U$ ]/ H% ~4 V  omany houses at prices that exceeded fundamentals.
9 n! k. a: p8 |" J# ^$ oRegionally, 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
very time that the resale market has swung into strong
* i( O$ T( B" Y% Q- |! }/ O* _buyers’ territory. Homebuilding in the Atlantic provinces
. o# h. @5 ^5 Q3 ihas been relatively balanced but, while not plagued by structural
, V  P' B2 @1 Hweakness, will be singed by the downturn nonetheless.
/ t7 V+ W0 l$ R: e5 x* a* N% UQuébec shows signs of strain – especially given the
/ A- ?+ ?9 ~/ X* Z7 |strange accumulation of unabsorbed multiples on l’Île de
6 P4 o8 D9 y  W3 G4 |Montréal – but recent building has been relatively balanced,
8 X. k' `* c3 W3 _+ Bgiven the province’s history of under-building and low ownership
rates. While Ontario homebuilding will reel from a
& Z. X# }* |$ ^4 Ucyclical downturn, the degree of structural weakness appears
) U' k% X/ N# |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
reach completion during 2009. If absorption rates fall, as
  \9 e) h: F+ lcyclical factors would indicate, condo inventories could
" c7 `+ X/ x# P8 I9 ^spike severely – particularly in Vancouver. However, while
" A0 u4 p) E% Lresidential construction in B.C. will definitely droop, we
3 x% ~- J- B$ z4 V- [( t* Q( ianticipate that the West Coast will continue to benefit from
inter-provincial and international migration over the coming
5 c  G' Y4 g- g: O" {  Syears, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
4 Y* T: h* f/ G- i6 w/ IOVERPRICED AND OVERBUILT: CANADIAN HOUSING
& [8 z0 a. n  X6 ]9 ]+ f2 d( O& p2 ?MARKET RETURNS TO FUNDAMENTALS
' ?4 ?) r+ o- sGrant Bishop, Economist
0 g; h: r2 `6 x3 E# ~7 }416-982-8063
Pascal Gauthier, Economist
416-944-5730
. k: J. |4 i* `
7 ]. |/ {4 Z  C1 s5 |http://www.td.com/economics/special/gb0409_housing_exec.pdf

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