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
% U" [8 M* V; ]* E4 vprices exceeded the value of housing that was justified by
" R/ u; M2 t* r$ h/ u0 U# y! g0 B5 {; lfundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
8 N% R' }  F( d12%, an excess that was exaggerated in the past
three years.
By “overpricing” we mean that prices detached from
3 _( A9 R! ]1 a% f1 Qtheir fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
' z. u: \5 R! l- z/ q; Iboth a cyclical downturn and a return of house prices
to fundamentally justified levels.
, B% W" l8 q7 J* EWe consider “overbuilding” of two forms: “demanddriven”
8 s6 Z& s8 L+ W4 y6 Q% U6 Lwhere homebuyers buy up too many houses and
+ J! r8 @1 n/ C5 i- T2 a( Tthat 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
“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
; n/ v& p, A( Y2 X* uthat is now being rapidly reined in.
2 r, O4 r4 a6 w: I# {& j/ GWhile 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
from the cyclical downturn, house price growth will
/ C2 P1 M& e! Lremain choppy and new residential construction will be
7 o& i- O9 {( S) |5 f: A2 j, cdampened, owing to this structural weakness. Construction
8 w% {( P% h4 b! x) ^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
) k3 {0 u* U* K2 I/ b( G4 f125,000 starts over 2009 with a trough around 115,000 units
8 _% w$ r, ^3 k$ y, Zin the fourth quarter.
To quantify the degree of overpricing and overbuilding,
7 Y5 g0 P& W) a* n# n- x+ `4 rwe first develop an empirical model, based on long-run
fundamentals of house prices and housing starts in each
province. Affordability is the key concept behind home
values since house prices should track incomes over the
' t# k( s# o1 f$ L' p5 clong-run. Since homebuilders build to meet demand, we
* N! j* e/ W- K3 }; B/ Yregard housing prices and household formation as the drivers
- w# h5 a2 L7 a( F& @  pof residential construction.
To examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
8 z" q0 d2 s7 I% m; x" Kwould have occurred if housing had been priced
- `! Q/ v" I3 ^! ?optimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
( c  S9 i6 u9 y/ o& ^- v+ Sunits were being absorbed, homebuyers simply bought too
; m' D% I6 _" S) y+ R, a9 C# |many houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
3 S# j0 A$ j4 Malready witnessing surges in their unsold new homes at the
# o# F* o0 G; M# D$ k5 t  t" xvery time that the resale market has swung into strong
buyers’ territory. Homebuilding in the Atlantic provinces
8 T/ K+ J8 y% A+ Y% W/ xhas been relatively balanced but, while not plagued by structural
weakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
strange accumulation of unabsorbed multiples on l’Île de
& \9 S' T) v/ @# [0 I! W! Q! [0 AMontréal – but recent building has been relatively balanced,
given the province’s history of under-building and low ownership
, H7 Z  b( J0 u3 O. \! urates. While Ontario homebuilding will reel from a
6 W- B9 S; x0 Gcyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
( S  w5 `3 Z  X$ bcondo market. Both in Toronto and Vancouver, historically
  F9 y; C  p$ Z# `! A: ]* f0 }2 xhigh levels of apartment-style units presently under
construction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
; }1 B1 u; Y( ^3 G% T( e: Qcyclical factors would indicate, condo inventories could
( w) ], [$ ]4 N7 fspike severely – particularly in Vancouver. However, while
residential construction in B.C. will definitely droop, we
* S5 U  D3 V# ^0 `1 }' K7 `6 H/ u  Manticipate 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.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
+ I  n" V/ n; X# mMARKET 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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