TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
' t. A0 ]4 u5 a* _7 {from 2002 to 2008, unsustainable price increases drove
' I. M1 |" B8 s9 j/ P0 Hunsustainable levels of building. Our view is that house
prices exceeded the value of housing that was justified by
" }' \. |" {1 h& S5 i- Zfundamentals by approximately 9% nationwide. This
& g% n4 N) x; C% Soverpricing compelled a level of residential construction
; [! T0 @5 ^( S' B; Lthat exceeded its fundamental-justified level by approximately
" k9 w& n" q+ G$ D1 Y12%, an excess that was exaggerated in the past
& O4 |1 G1 m2 E6 r6 B+ E/ sthree years.
# U' Z# p0 ?) fBy “overpricing” we mean that prices detached from
; _1 g; T. G/ F2 N% Dtheir 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”
& x: A5 j/ J; T% I. z' e2 `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
& L& l% \4 l* v# m“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
" n& E. I2 w1 @# R$ @, M" S7 pthat is now being rapidly reined in.
7 q) v( Z& M( D/ z5 Z2 eWhile most markets won’t face U.S.-style overhangs,
" ~' k) m  C  L, Qthe construction of too many new homes over the boom
6 U; n8 g* I& h$ J9 `  P, F4 G" Imeans 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
1 N7 d$ j1 ?% xdampened, owing to this structural weakness. Construction
3 e& g  R+ R, I6 v9 Xis now undershooting fundamentals and we expect this
8 ]5 L3 A4 Y" f. j+ lto persist over 2009 to 2011. We anticipate that nationwide
! O5 ~6 n+ r' h& ^. Lresidential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
5 h0 o2 F/ a( S$ ]4 LTo quantify the degree of overpricing and overbuilding,
1 O/ ?. g; P+ l- Z  nwe 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
! J  v1 P6 D- K0 c( vvalues since house prices should track incomes over the
& @- \; W: g3 vlong-run. Since homebuilders build to meet demand, we
% @5 \# N: b" V0 gregard housing prices and household formation as the drivers
: P% l# a" E+ c* u# Oof residential construction.
6 X) x  Y( \/ Q. U  HTo examine the degree of overbuilding, we employ a
; b1 C7 B; ^' s! C7 _  ]“counter-factual,” asking what level of residential construction
3 \8 S7 ]; d. Q+ X- i3 N  B( }would have occurred if housing had been priced
5 Y$ P. n; G5 V% e6 E( ^0 }" Goptimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
# h$ `7 q! f5 t* ~3 ?7 A: x3 r1 \units were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
& o! [( _) v/ s0 ~. ^( }, x% A9 Gwhere housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
& d3 d( `, D  Q. ^very time that the resale market has swung into strong
( e+ m2 ]: o$ d" v# n6 |9 Ibuyers’ territory. Homebuilding in the Atlantic provinces
' n8 o9 e7 f! R+ F$ C* ~* I8 @: ]- p3 N2 ohas been relatively balanced but, while not plagued by structural
weakness, will be singed by the downturn nonetheless.
+ L1 n, v1 Q* O7 LQuébec shows signs of strain – especially given the
4 C3 E2 Z+ d: a, s" c. n! Tstrange accumulation of unabsorbed multiples on l’Île de
Montréal – but recent building has been relatively balanced,
0 |. }; e2 J3 l1 u% f7 I! Ugiven the province’s history of under-building and low ownership
* g) T3 |- G- L) h" t: F* xrates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
% |( F+ _% O; t* e( W: ncondo market. Both in Toronto and Vancouver, historically
  k3 z6 O+ i# B$ G% @  Rhigh levels of apartment-style units presently under
+ j* I$ h* f( r1 m: Z$ n5 Wconstruction mean that record numbers of condos will
5 O& y  E* L3 v. g7 Xreach 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
, X3 N  z7 S- ^1 f4 A1 b+ w6 S" q! Tanticipate that the West Coast will continue to benefit from
inter-provincial and international migration over the coming
years, which, along with improvements in affordability,
  t7 p1 O1 m* s  g# I- nwill alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
Pascal Gauthier, Economist
3 r2 N  z1 t6 ?416-944-5730
2 R9 i( r- G+ h1 m+ z" Z
http://www.td.com/economics/special/gb0409_housing_exec.pdf

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