TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
2 p0 P3 t2 l4 J1 C$ R# Gfrom 2002 to 2008, unsustainable price increases drove
) B+ S8 G$ U, i# Yunsustainable levels of building. Our view is that house
prices exceeded the value of housing that was justified by
" m8 }& I) N0 a1 [6 qfundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
% v6 o& I. [4 Z$ b5 Z; M! athat 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
* A2 F* d" Y- Lboth a cyclical downturn and a return of house prices
to fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
5 f+ _3 x! x& A, Q1 Z, S- I7 O9 }where homebuyers buy up too many houses and
- X* z2 w; E% r( Vthat this demand cannot be sustained; and “supply-driven”
$ X' v0 V% c  H( a3 s8 [4 cwhere builders accumulate excessive inventories. Although
& g' \* ?2 T+ f8 Y! U8 M# wthere is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
8 U- E  w% R! A/ i1 C- M1 a4 hthat is now being rapidly reined in.
/ q: H/ {" s* y  r3 E4 V  bWhile most markets won’t face U.S.-style overhangs,
the construction of too many new homes over the boom
means a deepened slump. This overbuilding will likely weigh
on markets over the next few years. Even as Canada recovers
  J$ E5 T, ~3 z& a* u- U& lfrom 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
; G0 v9 h' x2 h. }" o4 |+ h# l' yto persist over 2009 to 2011. We anticipate that nationwide
! {9 a! F7 A6 a2 Zresidential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
8 v7 F9 C  Y# b4 g% N9 n/ ein the fourth quarter.
1 \  l) N; ?2 D$ _* eTo quantify the degree of overpricing and overbuilding,
2 K& e0 @2 b6 M1 f2 Twe first develop an empirical model, based on long-run
fundamentals of house prices and housing starts in each
3 k9 F* }: l8 Hprovince. Affordability is the key concept behind home
, H2 S) e# q) ~. qvalues since house prices should track incomes over the
( X( o# K4 ^3 |long-run. Since homebuilders build to meet demand, we
regard housing prices and household formation as the drivers
+ H; Y/ L" M, ]4 Y; I, }$ Gof residential construction.
. E7 c  m" Q$ e  ~7 \" nTo examine the degree of overbuilding, we employ a
6 E5 a( k1 o& V1 Y2 M" b“counter-factual,” asking what level of residential construction
* |  x! ], v) O) [0 n0 @/ Rwould have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
8 ^& B- I$ l; G. s- |+ ffundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
+ x  L% F' w3 o5 ]% j9 p# ~Regionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
! z; E! \  w) c& w2 o6 @population inflows. Saskatoon, Calgary and Edmonton are
/ g$ H, P0 r5 J' D! \- ?4 `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
1 O8 z$ F' Y8 f0 J8 a6 o6 d" qhas been relatively balanced but, while not plagued by structural
9 s( Y- s$ {  L5 o( H1 I5 jweakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
7 y! ]: |* X1 X' bstrange 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
rates. While Ontario homebuilding will reel from a
: O  y( d- b9 t. s& ~/ b* h/ Vcyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
2 H* }. O# F. D4 ]+ R, |high levels of apartment-style units presently under
construction mean that record numbers of condos will
$ c. l6 n. Z5 v+ b0 \+ oreach completion during 2009. If absorption rates fall, as
* e7 S% a7 a( @$ I- c. B' e& Rcyclical factors would indicate, condo inventories could
# b/ ^0 ^9 X1 E: Y5 Jspike severely – particularly in Vancouver. However, while
residential construction in B.C. will definitely droop, we
, C+ c( Y+ U* Q  Xanticipate 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.
1 u3 o6 A" X& R5 t. l: v& MOVERPRICED AND OVERBUILT: CANADIAN HOUSING
+ s) T* D% P( I0 k, |6 P& E) BMARKET RETURNS TO FUNDAMENTALS
& Y1 t, A9 u8 c  m2 U( pGrant Bishop, Economist
416-982-8063
Pascal Gauthier, Economist
416-944-5730
/ L/ y" F- v9 H, n7 f0 {0 I. `
http://www.td.com/economics/special/gb0409_housing_exec.pdf

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