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
+ P. _6 P9 J, F, aunsustainable levels of building. Our view is that house
prices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
& M% Y1 \7 C5 w8 moverpricing compelled a level of residential construction
) h7 r) k" u4 q7 I' K2 pthat exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
: a0 k9 ]# X( p! }, r: c$ |: `- |5 ^three years.
By “overpricing” we mean that prices detached from
6 r0 d, l+ w9 G' `# r5 itheir 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
, z2 ]3 J% z  w* A% Zto fundamentally justified levels.
2 v8 H" e: L- m2 o5 L5 d' W5 t# ~We consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
! F; J& Y/ C/ h0 ~; uwhere builders accumulate excessive inventories. Although
( O' l- g# W. o% W7 S  O/ lthere is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
# k- x4 e  y" j# @4 z6 Tthat is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
, \2 G1 V0 H# Z# Q' Y# bthe 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
8 o* c5 {& E6 jfrom the cyclical downturn, house price growth will
) F# z. n) p0 I% S3 {% Xremain choppy and new residential construction will be
! q, t2 n: v+ }. Y$ x6 Z+ ?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
residential construction will fall further to around
# _) R( x) a# q0 B125,000 starts over 2009 with a trough around 115,000 units
3 R+ d, c+ i- `7 |# p7 \% @in the fourth quarter.
! t; N; P; R* Q5 i" LTo quantify the degree of overpricing and overbuilding,
$ v' t6 d  n6 gwe first develop an empirical model, based on long-run
fundamentals of house prices and housing starts in each
8 @# m& R; e# E" _9 b/ F% cprovince. Affordability is the key concept behind home
values since house prices should track incomes over the
, G! n: J, }% [( }  m! rlong-run. Since homebuilders build to meet demand, we
7 W7 k" Y8 ~8 q$ |regard housing prices and household formation as the drivers
of residential construction.
To examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
& i% @; E9 ^6 f) h) _- ~0 ooptimally. 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.
2 K. |/ X, {3 N, i! o7 b( _Regionally, we see the greatest strains on the Prairies,
! `, s) G- M4 d& a$ {where housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
' {, ^9 Z( Y5 R1 e$ ~' valready witnessing surges in their unsold new homes at the
( |# ?/ h7 W, h$ V+ e; Pvery time that the resale market has swung into strong
3 B8 G/ L9 U% ^4 M. M7 ?, qbuyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
" E* Z, M( ]4 N8 @0 Vweakness, will be singed by the downturn nonetheless.
0 n  m7 w/ \4 P# V% J# c- g) }Québec shows signs of strain – especially given the
4 p  r; o  U4 l: m+ |1 Lstrange 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
& ]. y; J0 k6 G" Qrates. While Ontario homebuilding will reel from a
3 ?) p1 X% `) L2 u2 lcyclical downturn, the degree of structural weakness appears
* F& E( ~* [: klimited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
3 K4 b6 J1 `- q1 Z+ ]& J/ v& aconstruction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
" a% k- ?* ^# c& ]spike severely – particularly in Vancouver. However, while
9 s3 A$ `; S( b, aresidential construction in B.C. will definitely droop, we
anticipate 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.
, z$ }3 N6 \" l) }. \" k8 N& oOVERPRICED AND OVERBUILT: CANADIAN HOUSING
* \$ L* r+ B1 t& d! O( A& QMARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
9 b6 ^) Q5 z; }" O/ _Pascal Gauthier, Economist
$ R" y8 ^( T1 j/ t- w416-944-5730

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

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