TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
  G4 y# T! t, x% {% j; ofrom 2002 to 2008, unsustainable price increases drove
* b% e+ |2 r: c4 u8 h! ~unsustainable levels of building. Our view is that house
5 {$ |/ P' _; o5 K: vprices exceeded the value of housing that was justified by
. A  T+ T- ^- k  W; g# \# lfundamentals by approximately 9% nationwide. This
! d( r/ r& N# S" Ioverpricing compelled a level of residential construction
  T- E7 Q1 x/ ^/ @& P" V6 ythat exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
three years.
- f7 p# {" m  H. J  u' ^, ?By “overpricing” we mean that prices detached from
: [) V3 Q$ W! m9 jtheir fundamentals, as witnessed by a steep erosion of
# l3 ~+ U$ c) C- Z9 faffordability. The current unwinding of house prices reflects
both a cyclical downturn and a return of house prices
to fundamentally justified levels.
1 x& I4 p8 q) h" A% j% jWe consider “overbuilding” of two forms: “demanddriven”
, V# g) v! i: Z0 Jwhere homebuyers buy up too many houses and
that 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
. `5 r/ S1 o* S2 z* A; _“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
% N6 G; w. M' ^/ V% N2 j# ^While most markets won’t face U.S.-style overhangs,
8 {4 ]  B- X9 R' X7 I0 Bthe construction of too many new homes over the boom
# l# I5 M; [- P. Nmeans a deepened slump. This overbuilding will likely weigh
0 J0 V4 l( c$ h$ J5 {+ `on markets over the next few years. Even as Canada recovers
from the cyclical downturn, house price growth will
4 R* b  L; z, [; @remain choppy and new residential construction will be
' {) _& F3 D9 y4 r  Ldampened, owing to this structural weakness. Construction
! u) h, \/ m+ ^! `is now undershooting fundamentals and we expect this
" p% R5 ^5 X$ R, \! F/ _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.
1 o8 b( s. C6 y! ]To quantify the degree of overpricing and overbuilding,
we 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
" t. L5 |4 y4 }( Bvalues since house prices should track incomes over the
long-run. Since homebuilders build to meet demand, we
- ]& j$ R3 O4 V5 Z" X& Dregard housing prices and household formation as the drivers
of residential construction.
! n( m/ ?; M3 K  [" @% uTo examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
8 }* \$ j$ G4 Z$ B/ \9 [  boptimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
/ l, @1 Q$ R; Q8 x+ O+ C, Uunits were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
4 P" Q; B4 C1 V  Y1 Kpopulation 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
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.
. o) D: n) e  yQuébec shows signs of strain – especially given the
strange accumulation of unabsorbed multiples on l’Île de
- _1 y+ W: T6 e5 O" H" L3 \Montréal – but recent building has been relatively balanced,
6 q+ \" k4 ^8 D5 [5 F+ w$ cgiven 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
- O/ n$ Y: r. n- G  e5 Glimited – with the important exception of the Toronto
# M2 [5 p, [% H  u4 f2 E. s9 lcondo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
construction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
6 k2 B$ @" W3 X! ~9 _" }2 ]  Hcyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
3 ~6 L8 {8 c& y- @5 Oresidential construction in B.C. will definitely droop, we
anticipate that the West Coast will continue to benefit from
inter-provincial and international migration over the coming
years, which, along with improvements in affordability,
  `' k- C5 k& U! Awill alleviate some of the pressure from overbuilding.
$ Q4 i6 v" ?" K) WOVERPRICED AND OVERBUILT: CANADIAN HOUSING
0 D. p* b2 [: ?( JMARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
' X+ }8 `- P; \% \- r1 {# |5 @Pascal Gauthier, Economist
( u5 G/ `6 J+ G% {% y  d416-944-5730
& Z& J, I5 d6 Q0 G
http://www.td.com/economics/special/gb0409_housing_exec.pdf

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