TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
4 b) u; F1 K% Y( f, e9 k  nfrom 2002 to 2008, unsustainable price increases drove
unsustainable levels of building. Our view is that house
$ z, _, X! W3 D. O( U$ Lprices 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
' Y; [7 u4 D' }9 e) [: i8 [12%, an excess that was exaggerated in the past
  e3 c, m( f# I+ s0 a( lthree years.
By “overpricing” we mean that prices detached from
7 p5 i6 a6 r$ L& ]8 }their fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
# I$ ~- q2 Z" L3 P. c, r$ F- S/ n; Bboth a cyclical downturn and a return of house prices
+ s. T3 G, K: p+ Cto fundamentally justified levels.
4 j& h/ r5 q5 C# A1 FWe consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
. c! H# }) c1 d8 sthat this demand cannot be sustained; and “supply-driven”
5 u" L' J4 l* ]8 d8 Owhere builders accumulate excessive inventories. Although
+ g( C0 A" |. v! }( Y! 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
' H- }! n1 L8 A/ H" o5 F- u: Hthat 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
remain choppy and new residential construction will be
. s& n5 T. a  v: j+ B* A8 wdampened, owing to this structural weakness. Construction
8 M2 J7 G# u8 L$ G1 `* E4 x9 }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
125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
) q; Q# p0 B! T) u8 Q4 E4 ^To quantify the degree of overpricing and overbuilding,
we first develop an empirical model, based on long-run
7 u, }3 P  C6 g5 J: v# `fundamentals of house prices and housing starts in each
9 m; u# o; L' _8 v; H& X: e8 ]province. Affordability is the key concept behind home
% S! ]  y' |6 A- y8 K8 kvalues since house prices should track incomes over the
; R# F) G, Q6 H* }8 y$ x6 m7 ilong-run. Since homebuilders build to meet demand, we
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
optimally. We find that actual homebuilding exceeded this
1 W! w- [4 |1 E8 c/ u: k5 w+ \+ Mfundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
" |  D' F3 n2 ?many houses at prices that exceeded fundamentals.
/ }) e: j' A  ORegionally, we see the greatest strains on the Prairies,
6 w. d" S, s$ k- Y* qwhere housing demand will further contract under waning
4 W" O9 s. u8 Xpopulation inflows. Saskatoon, Calgary and Edmonton are
' _, U! w8 \& \already witnessing surges in their unsold new homes at the
: ?. k+ f* L. {" X& H9 c5 xvery time that the resale market has swung into strong
buyers’ territory. Homebuilding in the Atlantic provinces
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
/ n- J5 s  s1 W. eMontréal – but recent building has been relatively balanced,
1 b* t7 U  s" X5 }4 Ogiven the province’s history of under-building and low ownership
8 Z3 Q& q4 S7 ]rates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
; V6 x* _6 B$ C) l% O- B6 Kcondo market. Both in Toronto and Vancouver, historically
3 }3 |+ [3 K) k" `7 o* m+ khigh levels of apartment-style units presently under
8 p) y+ S4 u0 q) O1 L3 w6 e; S8 t2 G! Mconstruction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
6 o& c# X- d! S7 [$ t) @* y3 B0 W2 Kcyclical factors would indicate, condo inventories could
( A) ?3 Q" o1 a1 e( c% xspike severely – particularly in Vancouver. However, while
& N& o5 t; Q" v. d& x  h7 Qresidential construction in B.C. will definitely droop, we
anticipate that the West Coast will continue to benefit from
2 U/ E  m6 U# B, sinter-provincial and international migration over the coming
years, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
4 _2 ]. L0 u1 b  s7 p- uMARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
8 m3 T/ V  y3 b1 j& b$ J- i416-982-8063
Pascal Gauthier, Economist
( Q, c1 r& ^7 }- t416-944-5730

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

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