TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
  ?# U* |0 `3 G  X/ ?8 _! yfrom 2002 to 2008, unsustainable price increases drove
5 G, Y& p" I2 B5 z4 Qunsustainable levels of building. Our view is that house
2 C( d3 U( v/ r9 C! Vprices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
- ^% _" [& J6 n- F+ n3 |* Ethat exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
9 H0 s# {* ^2 |5 v5 H, Qthree years.
By “overpricing” we mean that prices detached from
% A/ S0 g. x9 N  [# ztheir 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.
1 I4 a, R, @. j5 a" W) g+ s* vWe consider “overbuilding” of two forms: “demanddriven”
, E7 a; m, R- H. q6 ~where homebuyers buy up too many houses and
( G% g0 I3 z  x; \that this demand cannot be sustained; and “supply-driven”
8 S  p* B0 T* _  A) r* v: n( M/ iwhere builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
* T8 k0 i8 Y3 I6 G& Ehomebuyers pushed homebuilding to an unsustainable pitch
8 {" b% b1 `7 \0 _& ythat is now being rapidly reined in.
3 d4 m# D& c' e& K: ^While most markets won’t face U.S.-style overhangs,
the construction of too many new homes over the boom
' m8 y2 l; u' H( h. u& r9 G2 D! pmeans a deepened slump. This overbuilding will likely weigh
1 S7 X+ l; I) F6 j4 r3 p: g& I$ Jon 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
; e/ b  |! U* \3 r9 Rdampened, owing to this structural weakness. Construction
3 i  C1 l7 H( q6 n0 x8 Ais now undershooting fundamentals and we expect this
* _. }! l6 y$ l% A6 W' v/ Y" bto persist over 2009 to 2011. We anticipate that nationwide
3 A7 W. A# G, G* A; {residential construction will fall further to around
4 Z: T& a6 w! Y; W125,000 starts over 2009 with a trough around 115,000 units
) O% S: Q0 P- e. @0 _8 U& iin the fourth quarter.
To quantify the degree of overpricing and overbuilding,
  \$ j; ]& Q$ C' J) W2 k. w' c' b1 }we first develop an empirical model, based on long-run
% T2 n- S/ D! mfundamentals of house prices and housing starts in each
province. Affordability is the key concept behind home
- d" p# z2 N8 }" c. l; o0 y$ zvalues 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
1 l0 |: o% {6 x: g# M3 ^of residential construction.
* U! O5 P: h& }& Z/ d. v8 STo examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
) D) R4 B. z: s  c7 ]1 ~fundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
! Y9 G* A3 [% x: J( D) Q. a- |2 Ypopulation inflows. Saskatoon, Calgary and Edmonton are
+ p- p, N; k  l9 kalready 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
weakness, will be singed by the downturn nonetheless.
. `" S* K+ o+ a2 b- TQuébec shows signs of strain – especially given the
. m# J- k9 i2 a* nstrange 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
  b% E7 H3 y  I3 H; W: Q$ l9 K: |rates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
0 [  s. P- _# Z8 w6 Alimited – with the important exception of the Toronto
& V5 u6 l& b7 i8 \condo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
9 L+ A" L* k7 Z, D! t9 r9 q  zconstruction mean that record numbers of condos will
1 a, P6 F  p$ Ereach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
0 }5 e6 p1 o4 o: J5 kresidential construction in B.C. will definitely droop, we
anticipate that the West Coast will continue to benefit from
$ B2 E8 J% J: a6 C/ |/ ]inter-provincial and international migration over the coming
years, 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
% W6 {' B& Z: J$ c( B5 U/ D$ KPascal Gauthier, Economist
416-944-5730
. X. I& R) x9 ^* I6 r
http://www.td.com/economics/special/gb0409_housing_exec.pdf

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