TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
9 b9 X0 Z$ q3 s# {from 2002 to 2008, unsustainable price increases drove
* o/ a% }1 E9 j2 n) {' ^unsustainable levels of building. Our view is that house
2 @0 I& |! @+ F0 c3 T$ P8 ^4 w+ X4 ?prices exceeded the value of housing that was justified by
fundamentals 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.
* a) U: T9 J7 S; U6 y! ABy “overpricing” we mean that prices detached from
/ R- c4 d1 Q# d: m/ B3 {their fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
+ s' D* x0 p1 \+ Xboth a cyclical downturn and a return of house prices
to fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
* C8 d  Y; O9 W9 ~. kwhere homebuyers buy up too many houses and
5 P  C/ I2 K5 \3 J( Tthat this demand cannot be sustained; and “supply-driven”
+ }1 ^4 \: W2 r  uwhere builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
# l' r  J, _; f% h' f2 S“overbuilding” was mainly of the first type, where
8 z+ j, s% J2 r8 k9 Ohomebuyers pushed homebuilding to an unsustainable pitch
8 S1 C. \$ j% h* j9 othat is now being rapidly reined in.
$ D- d  l' H( E8 R' a5 nWhile most markets won’t face U.S.-style overhangs,
6 Y' U8 r+ U) N4 @2 V- }) nthe construction of too many new homes over the boom
9 W4 f% q# L+ Dmeans a deepened slump. This overbuilding will likely weigh
on markets over the next few years. Even as Canada recovers
! o) K! {5 |6 Z' efrom the cyclical downturn, house price growth will
( E& n: l+ g  ^$ x1 |0 V  Yremain choppy and new residential construction will be
1 s, f- a- L  y3 B- i& H+ z5 Tdampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
" e0 f+ ]% I7 @: pto persist over 2009 to 2011. We anticipate that nationwide
; C" i8 a2 D* jresidential construction will fall further to around
* @6 Q/ }. g1 b8 O8 L9 H9 c; X125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
- I5 I6 t: x: h+ OTo quantify the degree of overpricing and overbuilding,
' K) W$ L5 P2 `" }/ o- Zwe 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
+ z, ?5 x, P7 U* ~0 o! K( v# uvalues since house prices should track incomes over the
long-run. Since homebuilders build to meet demand, we
regard housing prices and household formation as the drivers
" n7 h$ d) C) ?7 E1 q# {  t4 k+ Hof 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
- ~5 _' h% x- H  t. zoptimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
% z( R( X- m. Y. hmany houses at prices that exceeded fundamentals.
+ E  g" W! ^$ U8 C0 \$ ^$ NRegionally, we see the greatest strains on the Prairies,
6 ?* ^' ]* T, ?1 jwhere housing demand will further contract under waning
0 N8 Y% n) t6 X8 P& `$ s5 Q+ y4 F4 \population inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
; L! l& \9 d. c; J- \very time that the resale market has swung into strong
buyers’ territory. Homebuilding in the Atlantic provinces
6 P7 G/ @. \; @* _has been relatively balanced but, while not plagued by structural
weakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
strange accumulation of unabsorbed multiples on l’Île de
$ ?( q, J+ p3 V/ {Montréal – but recent building has been relatively balanced,
& o5 ^4 N9 m5 k5 Y  L- i% ugiven the province’s history of under-building and low ownership
2 b/ _. C: R$ h: jrates. While Ontario homebuilding will reel from a
. f- r% @+ ?8 h; o# `% g  C$ I, @cyclical downturn, the degree of structural weakness appears
! G! K. t- y* \limited – with the important exception of the Toronto
" M- X& K  Q5 w- Xcondo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
construction mean that record numbers of condos will
4 Y0 @6 S/ w) h) N& G2 Q$ f; vreach completion during 2009. If absorption rates fall, as
' ~) l5 f0 `6 Z. X6 t( mcyclical factors would indicate, condo inventories could
' B; F. ~. T) Q$ U% Rspike severely – particularly in Vancouver. However, while
2 i! ~9 e$ {; Y+ sresidential 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
4 R9 |" S$ y5 n! t$ [& S  {1 m+ {. ayears, which, along with improvements in affordability,
" ^/ ]) r2 w3 Jwill alleviate some of the pressure from overbuilding.
/ m* f9 c6 b9 R% {$ `, [+ D* `OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
6 U, [% i% u6 X7 z0 ~- y416-982-8063
Pascal Gauthier, Economist
416-944-5730

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

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