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
unsustainable levels of building. Our view is that house
( N0 G  o1 d( Q" e3 w+ ]! c; xprices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
+ u5 }* U2 Y" v6 U4 V# N5 poverpricing 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.
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
$ H4 `: H1 d3 {$ C% ^- Y( eto fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
0 x3 j7 Y0 e8 A& ~/ Y2 qwhere homebuyers buy up too many houses and
3 f9 m. Z7 P) H* y5 i- uthat 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
+ W  D! _5 D/ G7 M" h0 ~0 ?2 u“overbuilding” was mainly of the first type, where
! h" G* l; W1 E) y. N) jhomebuyers pushed homebuilding to an unsustainable pitch
) f, t: ]* M& A5 a  L/ O! ?that is now being rapidly reined in.
' S  O5 n. n' l# _9 a! tWhile most markets won’t face U.S.-style overhangs,
0 n8 k6 j3 [. G% L0 c  ]the construction of too many new homes over the boom
means a deepened slump. This overbuilding will likely weigh
" W' w8 z8 T: p  N$ ]1 hon markets over the next few years. Even as Canada recovers
( s: e1 N1 K1 J7 l) Zfrom 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
" y2 v9 C1 c( x$ _to persist over 2009 to 2011. We anticipate that nationwide
! b9 s- Z3 p% E& ~  q7 f) lresidential 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,
* e. B  I$ Q& Q, ?we first develop an empirical model, based on long-run
* v* \9 W$ J5 X( v4 c/ V9 ?fundamentals of house prices and housing starts in each
; G- g, A$ o# Z& lprovince. Affordability is the key concept behind home
values 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.
8 m, [! I: _+ A) h+ q/ iTo examine the degree of overbuilding, we employ a
$ J5 x( G( K4 _4 V* ?2 R5 I  l“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
. I2 i1 k/ G9 p3 Nfundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
) I9 ]5 c' z( N8 c0 f3 T9 ^many houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
. Q) B9 p# ?6 ^- v$ v0 B- D0 {where housing demand will further contract under waning
0 t" A  g3 S" gpopulation inflows. Saskatoon, Calgary and Edmonton are
1 w/ v- o! ?$ t  x* K6 h% lalready witnessing surges in their unsold new homes at the
very time that the resale market has swung into strong
0 W) c& m7 T6 Z3 ~1 ibuyers’ territory. Homebuilding in the Atlantic provinces
( K1 L/ Y* m- K5 O3 ^has been relatively balanced but, while not plagued by structural
$ p3 Z3 {. E0 I9 ?weakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
, ^: l4 C- g; l) W, `. \" U% pstrange accumulation of unabsorbed multiples on l’Île de
8 R- j# G1 f% xMontréal – but recent building has been relatively balanced,
) U* S8 [# q/ |! jgiven the province’s history of under-building and low ownership
7 Y6 C0 i- }: Yrates. While Ontario homebuilding will reel from a
( }3 {8 f6 _$ [cyclical downturn, the degree of structural weakness appears
% ]4 T5 k! \( u5 o9 P, Dlimited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
* ]. |7 K/ g4 N8 Y, V+ A/ g% ohigh levels of apartment-style units presently under
construction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
0 D' u: |- ~% y5 ]! k0 u; Z- nresidential construction in B.C. will definitely droop, we
anticipate that the West Coast will continue to benefit from
# N6 f8 T+ P) ]" P& a( G# H$ Z  {inter-provincial and international migration over the coming
5 s; S5 h( F8 G" F  P& zyears, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
5 \, W. f8 }2 A5 z! E) C* s) }' \' ]/ MMARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
# k4 R! v1 d5 J" Z416-982-8063
2 R' n  `; e8 I; gPascal Gauthier, Economist
416-944-5730
8 _8 I3 O0 w# Y9 ?
http://www.td.com/economics/special/gb0409_housing_exec.pdf

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