TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
' J; E0 N. ~2 ^1 W0 u) Efrom 2002 to 2008, unsustainable price increases drove
: Y& K* L; T. y$ f: eunsustainable levels of building. Our view is that house
prices exceeded the value of housing that was justified by
6 Y2 Q/ d$ T; ~: d, Kfundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
0 ^. v1 d1 w( w2 h" Q3 l: {& q3 N12%, an excess that was exaggerated in the past
, G' D% z" w) ^. Pthree 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”
8 M  b# Z4 W0 I# j- e( S, l) qwhere homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
( {0 n5 A, G! I1 O2 B“overbuilding” was mainly of the first type, where
, L' w5 E& K2 v- ]homebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
8 |$ p9 J, n/ m' yWhile most markets won’t face U.S.-style overhangs,
/ O, b0 S8 u0 N& H) l; Ethe construction of too many new homes over the boom
# x9 c+ V+ q3 K# D+ Rmeans a deepened slump. This overbuilding will likely weigh
3 G2 Z* l+ w) F, lon 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
$ u3 D8 C, @% b  w& d- }5 B/ u6 Edampened, owing to this structural weakness. Construction
8 p* P* q- q8 Z3 F0 `is now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
% D" i. s% p! b7 i: s9 \residential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
% ~& S: E7 x& \; h% h7 lin the fourth quarter.
# |$ `' \3 ~& b3 f9 OTo quantify the degree of overpricing and overbuilding,
we first develop an empirical model, based on long-run
- ~+ y1 G. w$ D  ]' y$ K" nfundamentals 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
- l! k, ^# V( [) c: hlong-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
5 r1 K" n# o. x" |“counter-factual,” asking what level of residential construction
+ p" D9 Y1 x9 Y! t' ?would have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
" C8 h2 K2 B7 V/ K/ v8 `/ P0 Ofundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
+ e8 z. c6 L+ n/ w; \: c% b& H' kmany houses at prices that exceeded fundamentals.
5 n  q- C* B: K4 |Regionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
# x3 v9 U+ W" E, g0 ^already witnessing surges in their unsold new homes at the
- H7 [! q8 F1 G8 z& Ivery 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
! v5 d% G1 a3 ?5 ~% cweakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
' |& t7 q) d! R3 ]7 Jstrange accumulation of unabsorbed multiples on l’Île de
Montréal – but recent building has been relatively balanced,
given the province’s history of under-building and low ownership
+ `4 s: O. {. H' v- @rates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
8 ^. |. D) X* f9 a: klimited – with the important exception of the Toronto
* }* i' J9 R6 a2 w  r* Z9 Hcondo market. Both in Toronto and Vancouver, historically
0 a$ t: [- t8 y5 shigh levels of apartment-style units presently under
9 H4 V9 p+ }* j+ bconstruction mean that record numbers of condos will
$ c3 d2 T& l7 h; U+ d& I4 `reach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
; D6 k0 s' s2 S. }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
years, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
6 O; N2 ^* |% @) `+ Q2 EOVERPRICED AND OVERBUILT: CANADIAN HOUSING
8 g' d2 G# ?5 ?1 \; ]MARKET RETURNS TO FUNDAMENTALS
( z/ z$ L, Y8 y/ sGrant Bishop, Economist
/ i8 w( k. E6 E2 B9 N: u5 R& X  S416-982-8063
Pascal Gauthier, Economist
# t) I1 G9 ?1 `9 S8 r8 u416-944-5730

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

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