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
$ T0 n! _1 l7 }0 V5 T5 punsustainable levels of building. Our view is that house
3 \/ M' z" t5 p3 ~) U4 Rprices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
$ R" c. P% D6 G4 d! I) coverpricing compelled a level of residential construction
# R2 D$ s! \$ `* uthat exceeded its fundamental-justified level by approximately
. g% r' z- N  _12%, an excess that was exaggerated in the past
) v) l3 D& {& U% |# c* Rthree years.
1 a. {+ V0 [  JBy “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
/ }5 J* b9 S2 |3 E" t) S4 j' |both a cyclical downturn and a return of house prices
to fundamentally justified levels.
9 b, v4 E1 w% {2 ?5 z4 dWe consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
6 ]! P! Q  t  E- x! Gthere is evidence of both types, we contend that Canada’s
0 k4 h. s, E2 m8 ?6 V“overbuilding” was mainly of the first type, where
* I' v) z9 h# r% E7 n! A$ {# Thomebuyers pushed homebuilding to an unsustainable pitch
1 c2 |" `( g$ q: gthat is now being rapidly reined in.
. y  {  \& r! B- O0 OWhile most markets won’t face U.S.-style overhangs,
' k! B5 L6 W+ bthe construction of too many new homes over the boom
means a deepened slump. This overbuilding will likely weigh
! k& f3 z- j" r$ @( e5 G3 Eon 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
to persist over 2009 to 2011. We anticipate that nationwide
residential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
$ r6 `% [( S3 K' H! P+ D4 T" rin the fourth quarter.
1 l  T, u& ?' _! n& LTo quantify the degree of overpricing and overbuilding,
) V2 C0 ]- w6 A' F! I0 ^) pwe first develop an empirical model, based on long-run
$ C0 k8 {4 R" T9 ~6 o& H. w* ]4 cfundamentals of house prices and housing starts in each
province. Affordability is the key concept behind home
% I" ^6 {) b5 `5 `values since house prices should track incomes over the
long-run. Since homebuilders build to meet demand, we
& \$ G9 |5 [+ _9 j1 @2 R3 B% dregard housing prices and household formation as the drivers
of residential construction.
2 m1 R7 `, m" Y; T. }# {: \To examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
# s5 G  T1 f$ P) |8 I$ H7 {would have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
+ {# H3 z9 X% YRegionally, we see the greatest strains on the Prairies,
  k/ H* N" y. \9 |% k3 swhere housing demand will further contract under waning
+ m, e' n! \) L! mpopulation inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
7 x7 G4 H6 o0 C3 bvery 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.
6 A, n% j( L& HQuébec shows signs of strain – especially given the
+ L3 L1 d" N+ [$ n. _% t1 [strange 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
! m& }3 p& \/ U  L' \1 mrates. While Ontario homebuilding will reel from a
5 O* v8 q, P' u* a* kcyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
construction mean that record numbers of condos will
7 a: o* E: S" N% m- m  ?reach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
- i( z6 e; u3 e- espike severely – particularly in Vancouver. However, while
residential construction in B.C. will definitely droop, we
6 i; R2 h7 P. x6 k. danticipate that the West Coast will continue to benefit from
inter-provincial and international migration over the coming
9 ?! b+ t3 R& G) p) v6 p% Ryears, which, along with improvements in affordability,
, B' b1 m1 P1 s0 Owill alleviate some of the pressure from overbuilding.
$ m+ K7 s6 P' G& I4 {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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