TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
% M  W  v7 K1 o. X! N# r" ufrom 2002 to 2008, unsustainable price increases drove
unsustainable levels of building. Our view is that house
2 ~. [- u% I' m1 Y( bprices exceeded the value of housing that was justified by
+ }% m& B' d" a) _. jfundamentals by approximately 9% nationwide. This
overpricing 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.
2 v, X) E' l6 ]  v6 e& TBy “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
# w' \2 J4 q& n+ haffordability. The current unwinding of house prices reflects
both a cyclical downturn and a return of house prices
, c, V7 c" `5 T* c6 P+ Wto fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
& k: y& A7 ~+ Q  j; i5 w$ Mthat this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
' Q& {' a, u( b! T# jthere is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
/ u/ @6 Q% J+ A7 E+ H) c  lhomebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
! D/ q! [0 n0 I0 U6 Athe 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
( Q8 O2 V6 T0 e7 `$ y/ h7 eremain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
' E, }% H& v7 Lis now undershooting fundamentals and we expect this
& f+ X: v" E1 _5 T( I4 Nto persist over 2009 to 2011. We anticipate that nationwide
% T' s1 [5 i; fresidential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
+ Z8 U, J  L4 X# F8 G% F" min the fourth quarter.
+ X& L9 l# A, O6 J: HTo quantify the degree of overpricing and overbuilding,
+ {4 J# O. B+ ?. Nwe first develop an empirical model, based on long-run
; e7 f+ G. \8 m- p# S5 Kfundamentals 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
% J1 ~: u8 l( |% qlong-run. Since homebuilders build to meet demand, we
7 v5 f) B" V, P% v) _  c2 Tregard housing prices and household formation as the drivers
5 X4 Q4 j/ J7 n6 H- K' nof residential construction.
To examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
4 o/ g5 S' j2 w9 d# Qwould have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
% R  y9 _: V$ k- }& S* Junits were being absorbed, homebuyers simply bought too
# o7 A' k( z* |) D1 K0 a& \; @many houses at prices that exceeded fundamentals.
$ I7 s3 g" s8 r9 n5 c" b+ j0 jRegionally, we see the greatest strains on the Prairies,
9 R- C) m# Y: P/ E! W% b- Awhere housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
. v7 h: E" ~4 |% Q7 D$ p& v" @% Mvery time that the resale market has swung into strong
buyers’ territory. Homebuilding in the Atlantic provinces
. m' v0 N& p9 H$ ghas been relatively balanced but, while not plagued by structural
weakness, will be singed by the downturn nonetheless.
6 I0 h  m, ~8 M+ E! VQuébec shows signs of strain – especially given the
strange accumulation of unabsorbed multiples on l’Île de
Montréal – but recent building has been relatively balanced,
2 K0 M! J1 Z, M0 \' O1 o1 c8 fgiven the province’s history of under-building and low ownership
+ V. p# J  E& c/ a" w8 mrates. While Ontario homebuilding will reel from a
0 L: h1 D+ q$ \4 gcyclical downturn, the degree of structural weakness appears
& I: W! @! Z. E+ r( K3 Vlimited – with the important exception of the Toronto
; _. S; t/ r+ Q7 \+ k" rcondo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
8 O! O" K; R+ X! c* a4 L- h; Z9 {2 Econstruction mean that record numbers of condos will
+ F1 Y. {9 ~% G" Sreach completion during 2009. If absorption rates fall, as
. Z/ i2 M* J1 x  L7 J/ c+ Wcyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
residential construction in B.C. will definitely droop, we
anticipate that the West Coast will continue to benefit from
2 H* e) f& [1 d' t2 e) ^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
$ r/ A2 x# M7 L# }! U  YMARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
+ d; K4 g6 B2 L" _5 l1 L; {7 }4 gPascal Gauthier, Economist
416-944-5730

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

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