TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
# \6 _) E0 H1 s2 V% r1 n) _" kfrom 2002 to 2008, unsustainable price increases drove
* d% z+ I4 b' g& zunsustainable levels of building. Our view is that house
prices exceeded the value of housing that was justified by
! f& F, }, s3 X1 G/ Y2 }' W- b) Yfundamentals 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
2 z4 ?9 x; T, _three years.
By “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
( I6 j3 S. q/ I$ Aaffordability. 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”
where homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
3 J3 D: g0 |: d, E- N: @! Ithere is evidence of both types, we contend that Canada’s
6 m& w. p# I/ j" Z9 X“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
" R5 {- V+ O4 Q; U) X- S0 F7 t$ kthat is now being rapidly reined in.
1 I& h$ |8 @; F9 m7 MWhile 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
. O, D$ S( E9 X( Mon markets over the next few years. Even as Canada recovers
- n0 d$ J8 f6 N: q8 b# g) sfrom the cyclical downturn, house price growth will
5 _0 J/ ^: I) P3 z% i4 dremain choppy and new residential construction will be
, k$ t' A5 b5 \# x6 ?2 Hdampened, 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
! O1 H' T  C' p% E( r% |$ Y  N125,000 starts over 2009 with a trough around 115,000 units
in 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
province. Affordability is the key concept behind home
2 d0 ]: a7 J8 T3 ]6 N& Ovalues since house prices should track incomes over the
long-run. Since homebuilders build to meet demand, we
0 J+ T# S. G  Y6 D/ ~regard housing prices and household formation as the drivers
of residential construction.
8 s2 A8 M# ^: e) u$ [To examine the degree of overbuilding, we employ a
0 |. }8 }- T) O8 |+ @/ q% l“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
& C! C1 \; Z4 g) E/ g/ ?' f+ T* woptimally. We find that actual homebuilding exceeded this
  |+ Q' b& w3 Rfundamental-justified level by about 12%. Although new
# i4 A, Q  G" N8 [1 a( ^8 q  }6 Cunits were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
; K1 b! S/ u4 t- |* z  e& }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
9 T( u( l, J; h! L7 h  @buyers’ territory. Homebuilding in the Atlantic provinces
9 a) y; p. v7 n* dhas been relatively balanced but, while not plagued by structural
6 V3 P, f% k5 hweakness, will be singed by the downturn nonetheless.
" A4 |# T. a( X' NQuébec shows signs of strain – especially given the
strange accumulation of unabsorbed multiples on l’Île de
. h5 h: G- H. H5 o$ C! |& q- n* S2 EMontréal – 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
cyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
. V8 N  p1 i5 ]- ?4 \0 dhigh levels of apartment-style units presently under
; m6 r: }7 u4 ?# w# `& V" f, @- mconstruction mean that record numbers of condos will
8 `# }: K, F$ z# Areach completion during 2009. If absorption rates fall, as
6 ^1 L& s- y4 k; A" N9 Y  Ecyclical factors would indicate, condo inventories could
, j# C/ d  x+ f/ w, `spike severely – particularly in Vancouver. However, while
) q, m5 h! D- O1 z6 X* dresidential construction in B.C. will definitely droop, we
5 a/ Z  f: r2 j2 U' F( ]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,
! h( ~! `" A7 q0 G4 x7 uwill alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
& h! m  I; [# G2 u1 a# Z6 i3 `" nGrant Bishop, Economist
( y" {) J# N5 S+ ~9 W416-982-8063
, P2 R1 [4 q/ _' e* E! pPascal Gauthier, Economist
416-944-5730

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

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