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
" _! M: Y0 L. s& _5 L* n3 A' k, munsustainable 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
# d% J+ x% j- m0 |three years.
8 q/ w  l9 S- j7 h. m7 eBy “overpricing” we mean that prices detached from
8 t6 P( o' q7 T* Atheir fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
; q1 R; G# Y3 A* Wboth a cyclical downturn and a return of house prices
$ A4 y# C6 @9 ~9 [to fundamentally justified levels.
* ]3 A- C* S0 l+ u0 v" qWe consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
, q% A! I. D3 x! n* Ythat 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
, d4 {; b3 u, k  f2 P“overbuilding” was mainly of the first type, where
  W# _, Z+ g" p% f' C: e! C, C5 mhomebuyers pushed homebuilding to an unsustainable pitch
that 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
) T! F" e5 J8 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
8 U% y0 s. y. nremain choppy and new residential construction will be
2 }9 k, H6 S% q* i9 I; Rdampened, owing to this structural weakness. Construction
. e! K" H- T  g9 D% p2 H- n( Q+ sis now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
7 V$ F0 e: x6 R: ~! Tresidential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
To 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
$ @4 {' B) {4 b* @1 y3 Zprovince. Affordability is the key concept behind home
values since house prices should track incomes over the
+ B( V$ b- D; wlong-run. Since homebuilders build to meet demand, we
! c* N% _) A- Uregard housing prices and household formation as the drivers
of residential construction.
# i3 L$ n6 h/ K5 k8 A4 }To examine the degree of overbuilding, we employ a
1 ]1 J. b" c! i  \/ Z" i- R“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
! k% S: F" D. z) O# qfundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
8 r+ O; Z5 T! S  ^9 v, b4 vmany houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
8 `6 @0 G2 I7 jwhere housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
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
. Y' S  `, X, g' b/ I7 hhas been relatively balanced but, while not plagued by structural
  n6 ^& }) h; P: `) H5 Zweakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
! ~* K5 O2 v! I# J  v. c7 z# ^strange accumulation of unabsorbed multiples on l’Île de
Montréal – but recent building has been relatively balanced,
+ _/ a6 U7 {8 O4 b' P2 u; o2 Vgiven the province’s history of under-building and low ownership
8 s9 z; S0 |# O  U- }0 brates. While Ontario homebuilding will reel from a
8 b) g$ \) j+ }cyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
" T% {) }/ F2 d; [0 Rhigh levels of apartment-style units presently under
construction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
! Y8 i+ T. m4 y4 H1 R! r( ycyclical factors would indicate, condo inventories could
' E! t- e5 `% p# h; _spike severely – particularly in Vancouver. However, while
& h1 M) \6 K* s% f  Q2 qresidential construction in B.C. will definitely droop, we
anticipate that the West Coast will continue to benefit from
! E5 D' q# m. T) T7 B# Einter-provincial and international migration over the coming
2 t2 Q5 I% }& E1 Iyears, which, along with improvements in affordability,
will 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
416-944-5730

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

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