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
6 l2 y; R+ R! e" g0 v) Punsustainable levels of building. Our view is that house
prices exceeded the value of housing that was justified by
  i( V" z' J( Hfundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
three years.
By “overpricing” we mean that prices detached from
# S$ E) h/ \) L7 M6 x- |their fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
( {* W5 w, V" g+ _$ Rboth a cyclical downturn and a return of house prices
to fundamentally justified levels.
# Y4 {8 J0 y' VWe consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
% m& T% c" ?* S0 H, N7 k/ zwhere builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
. j9 l9 ^8 m% V+ t, p2 X7 O( Yhomebuyers pushed homebuilding to an unsustainable pitch
& ^: j9 r3 R% q+ b# q" d) K/ zthat 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
2 u6 Y: [) H0 nmeans a deepened slump. This overbuilding will likely weigh
/ [4 k7 F$ }% m) Ion markets over the next few years. Even as Canada recovers
9 Z5 o- p8 b8 v6 b( V4 qfrom the cyclical downturn, house price growth will
remain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
9 N) r! i. D0 pis now undershooting fundamentals and we expect this
to 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
/ f8 \0 q3 v5 X2 A/ Pin the fourth quarter.
To 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
" V+ |: B9 [5 H2 v/ Lprovince. Affordability is the key concept behind home
7 m5 j: B. r1 t3 D: v& u/ s; Xvalues since house prices should track incomes over the
long-run. Since homebuilders build to meet demand, we
0 n8 ^: Z; L/ f; W* sregard housing prices and household formation as the drivers
6 ?( o: p4 [0 [  L/ X: N4 vof 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
( a% a4 W5 Y) e# M$ Doptimally. We find that actual homebuilding exceeded this
7 {1 P$ r, E. e( i) f/ Jfundamental-justified level by about 12%. Although new
, L- y' @, N6 W4 f( Eunits were being absorbed, homebuyers simply bought too
3 O9 N, b  r" D. w% Nmany houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
  G* Z( ?, }, Gpopulation inflows. Saskatoon, Calgary and Edmonton are
. D' Q. i9 R1 k. u; r" S$ talready witnessing surges in their unsold new homes at the
, w+ D" Q4 F# V$ t2 p0 u: n, ivery time that the resale market has swung into strong
' o" t' \; i& L. ]: Z7 v0 zbuyers’ territory. Homebuilding in the Atlantic provinces
3 R# j+ H1 R" c8 L' Hhas been relatively balanced but, while not plagued by structural
/ Y/ C( Y4 x& s( {# Pweakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
# [: x% `) q2 [" J+ y" U+ ystrange 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
5 X$ e/ z- p4 yrates. While Ontario homebuilding will reel from a
1 `5 t% v5 k0 pcyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
1 {9 L! r) R5 C! S! H1 Pcondo 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
7 R# @8 t. v4 w8 F; u- a) Jcyclical factors would indicate, condo inventories could
/ p7 b/ f; d. t% a: U! @! Ospike severely – particularly in Vancouver. However, while
residential construction in B.C. will definitely droop, we
, n0 K- T7 r( b( Oanticipate that the West Coast will continue to benefit from
inter-provincial and international migration over the coming
+ f+ S3 d3 W9 a* L& ]years, which, along with improvements in affordability,
' m% u% S4 Q# l& R4 a$ a- z: @% ewill alleviate some of the pressure from overbuilding.
1 }- O; O' g; E5 o/ Q" \1 g, y2 fOVERPRICED AND OVERBUILT: CANADIAN HOUSING
# F9 Y. U) |2 Q( X9 w% D9 [MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
/ `" O/ ~4 q- K) j$ z, ^" ]: j416-982-8063
2 v: g& }5 `8 y4 @: SPascal Gauthier, Economist
, E/ f! i  X* Q( J416-944-5730
: R5 S- x' \/ ^" o5 e+ W
) I6 [/ C6 h- ~http://www.td.com/economics/special/gb0409_housing_exec.pdf

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