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
unsustainable levels of building. Our view is that house
prices exceeded the value of housing that was justified by
: C8 {: Q: R# c3 n5 t2 M4 ?, w/ D6 Ofundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
! U% k0 `/ o; {: ^that exceeded its fundamental-justified level by approximately
/ U+ u8 w: s$ y$ x- o8 [! y12%, an excess that was exaggerated in the past
% @/ g, I) P  w/ L6 H9 {three years.
( w# f7 t7 g9 {5 g% OBy “overpricing” we mean that prices detached from
$ c! r0 c4 }5 z+ q3 x/ @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
. q2 k+ ?/ g( w( s7 h& jto fundamentally justified levels.
: E9 z% z& k" W5 |' nWe consider “overbuilding” of two forms: “demanddriven”
- S+ D( k3 |$ W+ k% cwhere homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
5 E% _( F! ^; w* `1 G& Owhere builders accumulate excessive inventories. Although
) [5 f1 Z4 L4 \, Sthere is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
0 O5 C7 ?; j/ D( e- z4 v/ ~* ?0 p% B  Fhomebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
8 \( d8 E, D9 k' H, ]# ^the construction of too many new homes over the boom
6 C% V- k. m, ]# |( ~- Omeans 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
% w2 n6 N7 {! B9 w3 M% Premain choppy and new residential construction will be
1 s& L" }; j! Q- V$ r/ m, B/ {dampened, owing to this structural weakness. Construction
5 h% t. H: j$ z+ s2 Dis 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
; y$ ~- p9 q8 t* G8 j, A- d. ]in the fourth quarter.
To quantify the degree of overpricing and overbuilding,
/ f1 B  J5 K' l. q: Xwe first develop an empirical model, based on long-run
6 Z+ j1 R/ u3 _' ffundamentals 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
4 |( x3 i! h0 U& U7 d6 x( Xlong-run. Since homebuilders build to meet demand, we
regard housing prices and household formation as the drivers
7 T# Z7 k' _- L% y# @% u; Rof residential construction.
. l2 A9 z% v5 PTo examine the degree of overbuilding, we employ a
& V4 l: f4 h3 y0 z2 ?, s“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
4 c2 F- {0 ~- Jfundamental-justified level by about 12%. Although new
* b+ J# |& K% p1 O% O+ F6 u# Cunits were being absorbed, homebuyers simply bought too
  p* B$ s2 E6 Vmany houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
' f# t7 I9 s) `already witnessing surges in their unsold new homes at the
very 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
+ Z, y" Q8 d7 Y  O2 Z+ Oweakness, will be singed by the downturn nonetheless.
7 k, @, J' B2 K* I3 ~1 J3 }Québec shows signs of strain – especially given the
strange accumulation of unabsorbed multiples on l’Île de
Montréal – but recent building has been relatively balanced,
* P0 B, F/ v- U, `given the province’s history of under-building and low ownership
rates. While Ontario homebuilding will reel from a
9 s- K0 f) a- v+ u2 Gcyclical downturn, the degree of structural weakness appears
' C% O: ^$ n1 _2 e$ r+ Jlimited – with the important exception of the Toronto
& u. m3 ^$ E7 L  |- X2 jcondo market. Both in Toronto and Vancouver, historically
' d; Y1 O6 {. M8 ^3 f; e% [high levels of apartment-style units presently under
construction mean that record numbers of condos will
4 h5 S2 F- `. s" E2 Q) D( G: preach completion during 2009. If absorption rates fall, as
' U, l9 S0 y* m4 Bcyclical factors would indicate, condo inventories could
/ j6 I3 n) y. f% W8 [spike severely – particularly in Vancouver. However, while
residential construction in B.C. will definitely droop, we
1 W) a1 o+ \" H4 o3 Xanticipate that the West Coast will continue to benefit from
# q2 e4 o. O- k$ p' W' m' finter-provincial and international migration over the coming
6 j' Q5 A" S+ e$ o  n( j6 yyears, which, along with improvements in affordability,
$ ^" a! i5 I" ewill alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
& D6 O2 Z% y: i! c0 n* qMARKET RETURNS TO FUNDAMENTALS
/ O! N! w+ ?  G( }; fGrant Bishop, Economist
416-982-8063
Pascal Gauthier, Economist
416-944-5730

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

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