TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
# \! H3 L, E1 L2 k2 b' {from 2002 to 2008, unsustainable price increases drove
" O* i) L, j0 S, T7 F5 H: G7 Aunsustainable levels of building. Our view is that house
prices exceeded the value of housing that was justified by
fundamentals 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
three years.
' W* {8 @  Y! B: ~" oBy “overpricing” we mean that prices detached from
7 i9 v9 H* b- C8 A: R" l0 q+ Jtheir fundamentals, as witnessed by a steep erosion of
9 m) @8 d- X2 v  L/ z& r6 Gaffordability. 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”
4 Q9 P. B1 q. M1 s" \where 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
2 h' e# Z) o3 [9 m“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
' f; j* c4 }1 g5 m, othat is now being rapidly reined in.
! w3 i2 D% t$ l7 S  M7 vWhile most markets won’t face U.S.-style overhangs,
the construction of too many new homes over the boom
0 h* H: X* c. Cmeans 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
remain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
/ T: q6 v' k: j: B4 Ato persist over 2009 to 2011. We anticipate that nationwide
' [* H8 V5 F. ~9 _' ?3 lresidential construction will fall further to around
2 G* |, U" W" c+ ?7 i) Y* `. B125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
6 F6 M$ W, V1 }6 X! C. o! Z$ J% Z& vTo 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
: f- K5 Q6 \$ Pprovince. Affordability is the key concept behind home
- A+ ~# E9 v! O/ ]. Y! avalues 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
of residential construction.
* n* _) _1 D) dTo examine the degree of overbuilding, we employ a
- S! r$ x1 H3 K7 }0 H# ~+ C( d“counter-factual,” asking what level of residential construction
7 X( A- S# d1 G/ ]0 f# zwould have occurred if housing had been priced
6 I. _/ F* `0 soptimally. We find that actual homebuilding exceeded this
3 X/ t+ f8 P+ ?7 l5 _5 y- J( v+ gfundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
8 H* Y" u4 }3 H7 p  m$ Y6 ymany houses at prices that exceeded fundamentals.
8 g6 I0 H/ K) jRegionally, we see the greatest strains on the Prairies,
2 y' V( h7 ^* [# h6 H4 swhere housing demand will further contract under waning
/ F( Q3 a4 K% D/ Cpopulation inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
' d, U) p3 j  |& D, ^$ ^very time that the resale market has swung into strong
( I/ E! v% D% Z/ dbuyers’ territory. Homebuilding in the Atlantic provinces
  K2 g4 z& _2 X  ^( n+ lhas been relatively balanced but, while not plagued by structural
7 V  A  t8 A, y" {3 eweakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
# A: u/ E+ K3 [) D2 Istrange accumulation of unabsorbed multiples on l’Île de
9 C% u% F  Q- b5 x" eMontréal – but recent building has been relatively balanced,
6 }% x' n0 E- q  l, D+ Y: P- k+ }given the province’s history of under-building and low ownership
  `7 B8 l* [8 {3 Srates. While Ontario homebuilding will reel from a
- y9 d2 t$ J9 \! Ecyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
" Q7 d: t& N# e; g9 u# o* T% A2 icondo market. Both in Toronto and Vancouver, historically
) e8 U0 |- a5 A+ j5 {  nhigh levels of apartment-style units presently under
* W! v' o8 Q1 p4 F& }construction mean that record numbers of condos will
- i( M/ D1 y+ k' M9 Ureach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
residential construction in B.C. will definitely droop, we
( Z8 s% M9 W. Janticipate that the West Coast will continue to benefit from
, v9 Z# H; |9 B* ~( einter-provincial and international migration over the coming
, S, V* f7 e0 G( uyears, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
4 g6 ~- U# q1 j& xGrant Bishop, Economist
416-982-8063
, R- }' J1 o! q" BPascal Gauthier, Economist
5 W; P  L5 K. S- L: F" ?- C416-944-5730
# f5 V/ q5 w4 P. h8 n3 I2 j2 [. `
http://www.td.com/economics/special/gb0409_housing_exec.pdf

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