TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
# E' X3 s* a8 r( o0 a" u- d" Yfrom 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
fundamentals by approximately 9% nationwide. This
- Y  \6 E# ~. voverpricing 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; x' c2 Z; |" `9 J: nBy “overpricing” we mean that prices detached from
, C/ C: Y* C( {! w  \% D! o4 K/ G2 Ztheir fundamentals, as witnessed by a steep erosion of
6 Y/ h$ `) g. }- T) C2 kaffordability. The current unwinding of house prices reflects
both a cyclical downturn and a return of house prices
7 E0 m( y: p; n7 cto fundamentally justified levels.
/ C4 o; ~5 n9 j7 u0 GWe consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
' m3 O9 B& \8 ywhere builders accumulate excessive inventories. Although
' L8 ?5 c5 s: j; Wthere is evidence of both types, we contend that Canada’s
# S# `5 e8 r3 V* v, ?: [“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
. `0 B8 D) d( l# _* kthat 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
$ M( O# n' X! ~) N* W6 K& L( Won markets over the next few years. Even as Canada recovers
4 h+ |9 c5 o4 @# S* ffrom the cyclical downturn, house price growth will
' x1 \8 Y6 M2 s- t8 z  f2 r, Xremain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
& i2 E0 x' p/ u6 N2 @& N( r- h3 Nto persist over 2009 to 2011. We anticipate that nationwide
- F! p8 J' R0 b- W3 e: Wresidential construction will fall further to around
! D: F3 o. r" G/ b, f7 F125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
To quantify the degree of overpricing and overbuilding,
7 E" G# e: |" k2 M" owe 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
long-run. Since homebuilders build to meet demand, we
5 Y$ F( r& F0 c. q" w2 Iregard housing prices and household formation as the drivers
* `& X; `0 u2 I8 o! p1 Iof residential construction.
To examine the degree of overbuilding, we employ a
) v! x, u% [8 M& K6 B“counter-factual,” asking what level of residential construction
+ E' W! ]7 S( t1 w5 X9 @would have occurred if housing had been priced
7 v5 u5 L; b! |# qoptimally. We find that actual homebuilding exceeded this
' \$ M- i% l; r1 H8 pfundamental-justified level by about 12%. Although new
, X; ~$ n9 V- a' munits were being absorbed, homebuyers simply bought too
' ]/ S" a" j" Y% ?' }+ i; emany houses at prices that exceeded fundamentals.
2 s! k0 ?- B5 Q) E& VRegionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
: Y! U" C& w. z4 D  y. Z& zpopulation inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
' H7 K  w/ m  L0 Q7 Vvery time that the resale market has swung into strong
+ I4 C: c, S% P# ~. A" qbuyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
' o+ b3 |+ l/ V: i- _weakness, will be singed by the downturn nonetheless.
6 P. C% n: V% l+ A; HQuébec shows signs of strain – especially given the
" r  U# W; [3 Nstrange accumulation of unabsorbed multiples on l’Île de
Montréal – but recent building has been relatively balanced,
, A0 z( ]3 j5 ?/ f; }+ t3 \given the province’s history of under-building and low ownership
' b. k+ Y. e* R2 Wrates. While Ontario homebuilding will reel from a
. h( A$ s& w/ Y; _9 fcyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
- |7 m6 @) y1 x0 H" D+ K6 w3 Q! Dhigh levels of apartment-style units presently under
construction mean that record numbers of condos will
, `6 E" {3 ~: O) Y( Wreach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
6 W1 S7 V' v1 P- x9 |spike severely – particularly in Vancouver. However, while
6 R, K; F, i& Y+ s) Fresidential construction in B.C. will definitely droop, we
7 V9 B) V2 \( w5 {7 Canticipate that the West Coast will continue to benefit from
inter-provincial and international migration over the coming
( u1 ?- @( M8 O& D( ^9 C; z* Jyears, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
4 o% c4 R0 @8 W; e' D5 YOVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
" V0 B# S. e9 f( k- ZPascal Gauthier, Economist
416-944-5730

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

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