TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
+ j8 s0 N" {+ O( U9 q7 qfrom 2002 to 2008, unsustainable price increases drove
unsustainable levels of building. Our view is that house
prices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
2 V6 g$ y# d) p4 i4 boverpricing compelled a level of residential construction
4 }0 v" z7 E& l/ |# B5 ythat exceeded its fundamental-justified level by approximately
" |- S3 z! [0 c8 z( V7 v6 n& A12%, an excess that was exaggerated in the past
% g5 D6 K8 Q! sthree years.
4 z! {" F# H9 d" c& f0 \By “overpricing” we mean that prices detached from
, A/ |9 W4 |* H! Ctheir fundamentals, as witnessed by a steep erosion of
. Y4 ~9 B( ?) [, u% C4 l5 Jaffordability. The current unwinding of house prices reflects
1 {; y; b. \' Y. Z. t8 d/ Gboth a cyclical downturn and a return of house prices
to fundamentally justified levels.
+ m( q0 \% }9 U: y7 ]: k- tWe consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
! [6 [! j1 t+ f' s  ^there is evidence of both types, we contend that Canada’s
4 W/ Z1 x$ B  e) Y1 O% W“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
7 n8 B' s! e0 b3 v4 h" Z7 Kthat is now being rapidly reined in.
While 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
+ P6 J* J2 S6 m% u1 J. ~3 r4 b8 |/ }from the cyclical downturn, house price growth will
remain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
( v8 j6 S& \# I! B5 _0 Nis now undershooting fundamentals and we expect this
$ b) o5 @& D. r% o0 {( v& eto persist over 2009 to 2011. We anticipate that nationwide
residential construction will fall further to around
# g  P4 y* _9 I) H# C125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
To quantify the degree of overpricing and overbuilding,
we first develop an empirical model, based on long-run
/ ]1 b8 I9 c' X; yfundamentals 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
0 t6 R, k" S( n6 s  Q" f- i9 k; plong-run. Since homebuilders build to meet demand, we
regard housing prices and household formation as the drivers
of residential construction.
" @4 q  b/ e& X1 ^7 L2 bTo examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
units 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
population inflows. Saskatoon, Calgary and Edmonton are
; R' e5 t; [1 F+ zalready witnessing surges in their unsold new homes at the
. I; b2 Z" w8 P4 v# Cvery time that the resale market has swung into strong
% M2 L; D9 [- n2 o" E1 ^  A9 cbuyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
weakness, will be singed by the downturn nonetheless.
$ q5 }& w5 e0 p/ L- ]1 C$ E+ ~, EQuébec shows signs of strain – especially given the
$ {; v9 U  j8 a! qstrange accumulation of unabsorbed multiples on l’Île de
Montréal – but recent building has been relatively balanced,
3 [& y$ q% e9 O; Z4 Z+ Mgiven the province’s history of under-building and low ownership
rates. While Ontario homebuilding will reel from a
' I, i' e" g2 V1 k+ M$ f* @cyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
0 E: x1 E' Q0 V3 q- H2 Ocondo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
construction mean that record numbers of condos will
, v, K. H! w$ o4 Hreach completion during 2009. If absorption rates fall, as
' u0 t/ m. A( j+ b8 G9 X: ~cyclical factors would indicate, condo inventories could
# T, Q; [1 Z: E4 S; ?spike severely – particularly in Vancouver. However, while
- Y1 R3 H4 }  N+ G! T, d( Qresidential construction in B.C. will definitely droop, we
+ n1 R& ^0 N6 _" a; _# `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,
will alleviate some of the pressure from overbuilding.
0 e7 _& R% M2 z( I5 S/ NOVERPRICED AND OVERBUILT: CANADIAN HOUSING
  l- f& S& T1 \% w/ rMARKET RETURNS TO FUNDAMENTALS
- c5 Y6 Z* |" ^Grant Bishop, Economist
0 G4 O4 y5 \3 M, }416-982-8063
6 d" K0 X8 I' J7 ~9 t! O# i6 R, I5 yPascal Gauthier, Economist
9 z$ q9 O7 j- C: ]% T1 w" I- Q, r, I416-944-5730

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

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