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
6 V/ H* i. }& ^5 Q- q, d/ e3 T% _unsustainable levels of building. Our view is that house
" \9 H2 B$ |. X0 ?5 Y, gprices exceeded the value of housing that was justified by
* u) c3 I% @# xfundamentals by approximately 9% nationwide. This
! v7 N5 m: L% K# d, Toverpricing compelled a level of residential construction
8 Q* y& K5 b. U$ ?8 i7 u- N6 |" z. Fthat exceeded its fundamental-justified level by approximately
. T: e% u% \; @- _12%, an excess that was exaggerated in the past
# I2 J& O& K" z( A) Uthree years.
$ d3 c, J( U% |By “overpricing” we mean that prices detached from
  l$ y- J* C) O# m3 q* Wtheir fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
both a cyclical downturn and a return of house prices
3 T8 a$ K5 w, t& E  [) D- bto fundamentally justified levels.
1 o8 R; ^, }7 d0 [0 B. n* @( C: n6 F0 b8 `We 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
there is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
+ B5 i+ I+ X/ n/ Thomebuyers pushed homebuilding to an unsustainable pitch
. j  A. ?' `3 e7 V9 \, ithat 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
; A. S( X% }, |: {; c) aon markets over the next few years. Even as Canada recovers
from the cyclical downturn, house price growth will
remain choppy and new residential construction will be
  c% A3 Z  {2 r2 y/ t# S. Cdampened, owing to this structural weakness. Construction
. o3 H" J! _6 E+ H) pis now undershooting fundamentals and we expect this
$ n" B1 i/ ?6 B) k. dto persist over 2009 to 2011. We anticipate that nationwide
* X$ q9 g$ ^* z( [residential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
6 [: T! P# A- m% M( e& k# yin the fourth quarter.
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
/ x- r$ w0 @  f! p- |province. Affordability is the key concept behind home
values since house prices should track incomes over the
long-run. Since homebuilders build to meet demand, we
$ E. f* X8 d9 pregard housing prices and household formation as the drivers
" h( h- v' A# u7 D" pof residential construction.
To examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
% u2 z$ H7 }1 Foptimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
. s2 A% u, a3 tmany houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
: R2 n; ^$ C. J  @# P$ Dwhere housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
4 B7 C  u0 S4 X7 T# n% Ualready witnessing surges in their unsold new homes at the
, |+ I1 x7 l$ y/ |4 Z6 d* |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.
7 e; p4 w5 a$ R( L% iQuébec shows signs of strain – especially given the
4 L, @. @9 i) E/ B0 ]strange accumulation of unabsorbed multiples on l’Île de
9 ~+ p+ Q8 a, j6 z& tMontréal – 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
cyclical downturn, the degree of structural weakness appears
3 U  c) Z# k! f8 P' qlimited – with the important exception of the Toronto
3 v6 p1 O% H6 o; j3 y3 ?: Icondo market. Both in Toronto and Vancouver, historically
4 {; u) s* r6 I# W* J; I& Z6 K$ v( nhigh levels of apartment-style units presently under
construction mean that record numbers of condos will
# C# f/ w& ^. p; W' r0 f0 Sreach completion during 2009. If absorption rates fall, as
- ^+ K7 p9 A9 X( C3 `* ccyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
- w" q0 ^5 }3 b3 Y2 e0 fresidential construction in B.C. will definitely droop, we
, U$ K( d" p* ^. C* ganticipate 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
MARKET RETURNS TO FUNDAMENTALS
! H  Y% q$ S7 B) ?Grant Bishop, Economist
416-982-8063
1 R- v. Q1 `- N/ L4 A$ t& vPascal Gauthier, Economist
416-944-5730
3 r, Q! C$ L2 A0 ~6 S' @
http://www.td.com/economics/special/gb0409_housing_exec.pdf

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