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 T4 U9 _: f' V) U  G4 eunsustainable levels of building. Our view is that house
9 b+ S3 f' y+ I. t, T) @prices exceeded the value of housing that was justified by
" [/ w/ i) X7 Zfundamentals 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
7 T( j: i0 E3 n5 ^$ a: D: dthree 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
both a cyclical downturn and a return of house prices
to fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
: p( |1 R. p& O5 \where homebuyers buy up too many houses and
: l% f4 U+ a. e( mthat this demand cannot be sustained; and “supply-driven”
* w7 G! z; y* T5 Ewhere builders accumulate excessive inventories. Although
  ], x( j$ ?! F# f  o+ uthere is evidence of both types, we contend that Canada’s
! z4 u0 Z9 D: L, t; ?2 T- ~0 j“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
( x+ P5 U/ f* B* Xthat is now being rapidly reined in.
% j1 V- z% W- X4 \While most markets won’t face U.S.-style overhangs,
! ?# V8 a7 h6 H  o- j& i5 pthe construction of too many new homes over the boom
means a deepened slump. This overbuilding will likely weigh
, Z6 b& v2 i1 l; }0 Uon markets over the next few years. Even as Canada recovers
from the cyclical downturn, house price growth will
8 B/ B3 Q  e' f; Iremain choppy and new residential construction will be
: O. h: v% ^- q) Q6 ?7 Pdampened, owing to this structural weakness. Construction
/ t7 @- {% l' b# Z9 lis now undershooting fundamentals and we expect this
. t9 M- g: E* `& a" o  U/ Xto 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.
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
! V1 U) m2 M0 o1 O) 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
# ]" h. Z$ M( ^7 x0 Lof residential construction.
' t8 X5 g$ a* ~$ T  wTo examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
7 O9 J) T$ H; Y0 Owould have occurred if housing had been priced
2 M6 f: D& A, `4 A$ c- qoptimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
% [- l3 k* g0 _many houses at prices that exceeded fundamentals.
: }  S; @% ]; I2 F9 gRegionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
# M9 l3 {. {7 r  lpopulation 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
' J+ [' d! X# w3 ]buyers’ territory. Homebuilding in the Atlantic provinces
( \  F! V% l% W. U$ b5 l7 [; F( ^8 Whas been relatively balanced but, while not plagued by structural
% ^/ r; P/ n# z$ Kweakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
strange accumulation of unabsorbed multiples on l’Île de
' b! w6 X/ q7 D; MMontréal – but recent building has been relatively balanced,
+ c+ W7 d2 O7 ^# W/ Kgiven the province’s history of under-building and low ownership
& ]2 K4 B" Y$ m5 a* Prates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
0 }( |" j, Q, ?; H+ Mlimited – with the important exception of the Toronto
5 S# d7 M: l5 Z+ }  W) f0 e, icondo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
. `8 v3 J: n/ o5 T! t. zconstruction mean that record numbers of condos will
# G( {; R, f/ p' w) W4 ]  H+ ]) J6 rreach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
7 J0 v# b5 M- h7 ^spike severely – particularly in Vancouver. However, while
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
7 V5 _* u+ D4 {7 u% J' F0 cyears, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
) W4 X1 R" M- n' y# K% WPascal Gauthier, Economist
" V+ r* C) z# B/ i& f" L416-944-5730
4 E3 R9 c; y, I5 n8 _6 ~
http://www.td.com/economics/special/gb0409_housing_exec.pdf

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