TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
# p  T) a/ N% b" A$ o5 Kfrom 2002 to 2008, unsustainable price increases drove
; N% M7 v9 ?# ?0 v3 f( d# Yunsustainable levels of building. Our view is that house
4 C1 y  z0 W% W+ G" ~, tprices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
$ E& Y8 @- G) F5 G0 e% Y) Mthat exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
: z, O) ]( u- b- ?three years.
) P; E, ~! S) X3 rBy “overpricing” we mean that prices detached from
7 [+ O9 \! p7 H+ F) Xtheir fundamentals, as witnessed by a steep erosion of
1 G' y" C  a+ W7 m+ H' Paffordability. The current unwinding of house prices reflects
both a cyclical downturn and a return of house prices
to fundamentally justified levels.
. z- `  @# d$ B1 {7 aWe consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
$ v3 n/ L8 l) s& L1 Pthat 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
0 ^8 d# f- L% v1 G! s“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
$ m& `5 Y6 L4 {$ ?* O) p! ythe construction of too many new homes over the boom
means a deepened slump. This overbuilding will likely weigh
$ z7 ~+ M2 q/ [- s, \3 k' d7 {on markets over the next few years. Even as Canada recovers
from the cyclical downturn, house price growth will
  G4 a3 N* t/ l" m7 e( \remain choppy and new residential construction will be
: c3 A( C) W! U# C3 Idampened, owing to this structural weakness. Construction
- ~2 ?2 K8 F8 m9 ^0 Z! Wis now undershooting fundamentals and we expect this
1 v( g/ F% F, \) e4 w* J9 ~$ T  ^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
in the fourth quarter.
& t" H( ^4 W$ u; F$ N3 `! q0 W! WTo quantify the degree of overpricing and overbuilding,
we first develop an empirical model, based on long-run
! s1 O1 a$ S/ F. S4 Dfundamentals of house prices and housing starts in each
" X6 r9 c" i6 R- k" n3 q; m6 cprovince. Affordability is the key concept behind home
6 x# x2 _9 n& }values since house prices should track incomes over the
4 T! q- D3 ?2 O' {; g4 |' b; D" q" \long-run. Since homebuilders build to meet demand, we
: a$ q3 \% c  a( @! @* O  Uregard housing prices and household formation as the drivers
" F- {2 ~2 ^0 b9 y, Bof residential construction.
To examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
2 q. ]; K9 O$ E, o& s! f. ~$ _+ d# doptimally. We find that actual homebuilding exceeded this
8 F0 k7 m/ g3 c. J  zfundamental-justified level by about 12%. Although new
6 N% |. z* X" V0 u0 tunits were being absorbed, homebuyers simply bought too
' X' {( w# W. f2 B7 k/ hmany houses at prices that exceeded fundamentals.
3 m( _( ^3 D, ]# T* Q9 h4 G) v: ^Regionally, we see the greatest strains on the Prairies,
1 _  m1 B# ^, G5 e, Vwhere housing demand will further contract under waning
1 M/ D$ ]0 J& I) Upopulation 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
" S% {+ e) w3 ]% Mbuyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
  ]" U) k$ G/ I+ Aweakness, will be singed by the downturn nonetheless.
+ e7 A* s6 l1 p0 I, z8 UQuébec shows signs of strain – especially given the
& y  |& y/ ~1 |8 D4 M8 u6 x; L  kstrange accumulation of unabsorbed multiples on l’Île de
Montréal – but recent building has been relatively balanced,
$ E* }6 _  Q1 B  r; l* X% Egiven the province’s history of under-building and low ownership
rates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
# Q( z& n$ f" d- F' c$ y* z5 vlimited – with the important exception of the Toronto
2 k* f9 ^$ y& Zcondo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
* Q# `9 X/ `2 k, w, I) W0 mconstruction mean that record numbers of condos will
9 o1 w) j3 T  i+ x9 u; [reach completion during 2009. If absorption rates fall, as
  O& ?  w! G8 o( icyclical factors would indicate, condo inventories could
0 O& c  J/ H: P& a% J3 ]( cspike severely – particularly in Vancouver. However, while
: M6 S; Z# b& ]7 v* zresidential construction in B.C. will definitely droop, we
& C: T5 N. T# p! M" B" h+ \& B3 Eanticipate that the West Coast will continue to benefit from
inter-provincial and international migration over the coming
years, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
5 j. e" O8 U+ d2 O5 i* @OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
; I( J9 b$ d5 v* KGrant Bishop, Economist
6 d4 P- w9 `9 ]. \416-982-8063
Pascal Gauthier, Economist
1 T/ T+ g' C0 k7 v* [% i+ m' b+ V416-944-5730

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

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