TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
: G. M% Z" k3 i" \from 2002 to 2008, unsustainable price increases drove
unsustainable levels of building. Our view is that house
prices exceeded the value of housing that was justified by
: j! v' u& V2 ~fundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
! d8 o% S3 g  _% F% K0 J, I12%, an excess that was exaggerated in the past
5 t" V2 G# M& ~6 [7 Ethree years.
By “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
+ g  }- I; L0 ^0 Qboth a cyclical downturn and a return of house prices
" x% x! U; e4 B7 V3 dto fundamentally justified levels.
- z' `( _9 N6 kWe consider “overbuilding” of two forms: “demanddriven”
$ g3 O( z; b7 M2 r. xwhere homebuyers buy up too many houses and
8 H+ B. W% Y9 X, D  X  f. S* Lthat this demand cannot be sustained; and “supply-driven”
9 g- t+ W: ~  W/ Owhere builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
7 o/ }* E8 C" _0 khomebuyers pushed homebuilding to an unsustainable pitch
7 Z* W6 y0 v! C& ethat is now being rapidly reined in.
- h+ b( i. z6 @0 N$ U8 I$ vWhile most markets won’t face U.S.-style overhangs,
$ B. x# ^# h% ]" m1 |5 }4 M: othe construction of too many new homes over the boom
5 }" a6 Z8 |, G& J0 r0 Z( e7 ]means a deepened slump. This overbuilding will likely weigh
on markets over the next few years. Even as Canada recovers
# v5 q: E* l) e# C  s& @from the cyclical downturn, house price growth will
* [1 Y" K: j) C0 f  v% wremain choppy and new residential construction will be
/ A* D- W! R& w7 [) b* w% Zdampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
# O% }3 w$ G; `0 n$ ?2 Ito persist over 2009 to 2011. We anticipate that nationwide
, o: T4 `6 A6 W3 X6 O4 Rresidential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
# N1 a7 u# Z% O- ein the fourth quarter.
To quantify the degree of overpricing and overbuilding,
* u; T7 h% |, I, Z' o1 p' }3 Fwe 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
values since house prices should track incomes over the
8 s5 p' A7 A  Glong-run. Since homebuilders build to meet demand, we
regard housing prices and household formation as the drivers
& u( o. D7 x8 S; ]' \6 D, p4 u, i( nof residential construction.
4 u! _* P& Z8 p! q4 S2 kTo 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
+ J9 f0 |: L4 [* G; Nfundamental-justified level by about 12%. Although new
/ m% {. Q) u* T& M! a2 U; Funits were being absorbed, homebuyers simply bought too
" w0 e9 C% s" r; z7 emany houses at prices that exceeded fundamentals.
: C8 h1 j  v/ R; uRegionally, we see the greatest strains on the Prairies,
6 `3 I% w. t7 dwhere housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
$ o) p( _# C& p4 x6 y7 Every time that the resale market has swung into strong
buyers’ territory. Homebuilding in the Atlantic provinces
! N& G% R# |! d1 @  L" ~0 b' `+ n% ~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
, ~5 v! \! w' y. y5 Q, t4 Pstrange accumulation of unabsorbed multiples on l’Île de
+ y# T! B2 w' V: E) t. oMontréal – 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
, b) \; q7 R- }6 a2 {) b8 Rcyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
0 M& z; r/ P, F8 ^- |construction mean that record numbers of condos will
( L4 v. g4 ]3 |3 `2 {; Treach completion during 2009. If absorption rates fall, as
9 s" a* I# A% }+ y3 p  |cyclical factors would indicate, condo inventories could
, n5 @  g9 Z4 @" k6 c/ Aspike severely – particularly in Vancouver. However, while
$ j( {9 F$ I5 E% v0 w" o5 \residential 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
( U) R4 p+ M' J& C0 }years, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
" w- v) j/ z% Z: n  x: r. SOVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
7 i9 H. d0 W  w2 pPascal Gauthier, Economist
416-944-5730
3 Q6 ]/ e9 c- R% G2 x
http://www.td.com/economics/special/gb0409_housing_exec.pdf

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