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
  p6 R& g0 b0 B4 V9 Vprices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
. n+ D* Q1 P; @' M" h' x& n( Z12%, an excess that was exaggerated in the past
three years.
By “overpricing” we mean that prices detached from
1 Q9 M& H' Y9 w9 Ttheir 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
to fundamentally justified levels.
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
  [& b' m( i2 P+ K6 v/ P2 A8 b2 e( }. tthere is evidence of both types, we contend that Canada’s
+ d. y) |& I$ n+ t  ~“overbuilding” was mainly of the first type, where
1 S# Z! ?2 C, ]+ Lhomebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
" h& T0 J# q1 U/ R7 ZWhile most markets won’t face U.S.-style overhangs,
  T4 e  Y. B% a/ e# n7 i9 W. ?/ S$ q4 @the construction of too many new homes over the boom
7 |2 D7 C/ c2 U  M  o8 t8 o) Zmeans 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
remain choppy and new residential construction will be
- k2 x# R' I; ?* vdampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
+ p. A# L5 P# H; K' _to persist over 2009 to 2011. We anticipate that nationwide
' o3 M# Y. k$ A. r6 bresidential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
* {: p( s3 V" i. K: ^in the fourth quarter.
To quantify the degree of overpricing and overbuilding,
we first develop an empirical model, based on long-run
3 a" Z6 ~  d' F$ V! tfundamentals of house prices and housing starts in each
6 e" H* s; C# m2 P1 kprovince. 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
regard housing prices and household formation as the drivers
! ~/ g; m$ W. ?of residential construction.
To examine the degree of overbuilding, we employ a
) C- I3 [  L5 ^* Z& P& V9 S“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
9 H% }" Y: B+ n# Doptimally. We find that actual homebuilding exceeded this
" A( U9 e+ z+ r8 C- K2 e! [fundamental-justified level by about 12%. Although new
7 B) y  }) T: Q$ V) Y6 Runits were being absorbed, homebuyers simply bought too
7 c7 ]: O$ a( X% g& @0 z4 Vmany houses at prices that exceeded fundamentals.
" u# F  B- l, y5 Y! p2 bRegionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
' w& t/ ?  P4 |) b+ O6 Hpopulation inflows. Saskatoon, Calgary and Edmonton are
9 I1 N9 x, k) R( dalready witnessing surges in their unsold new homes at the
7 c8 G! h" j2 V- a& y8 M$ Uvery time that the resale market has swung into strong
buyers’ territory. Homebuilding in the Atlantic provinces
) I- z( H( ?; p: P0 Y* B, W9 \0 khas been relatively balanced but, while not plagued by structural
/ u) _4 s/ O& l2 f% \* Gweakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
strange accumulation of unabsorbed multiples on l’Île de
Montréal – 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
( B$ F( l+ _6 T6 hcyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
' C" G$ {" a; B; s0 W0 [condo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
+ a/ s8 q, E5 y" |) L. C# }  f4 ]construction mean that record numbers of condos will
$ O1 \; n* b- @2 T/ G% freach completion during 2009. If absorption rates fall, as
# Q% N* B6 X" Qcyclical factors would indicate, condo inventories could
& n3 ]) g4 V7 q+ p& aspike severely – particularly in Vancouver. However, while
, r2 R/ X% q0 l' p$ y! I" e* Q4 xresidential construction in B.C. will definitely droop, we
. u6 S4 `. ~* Xanticipate 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.
! {2 G: d  x- w, j( rOVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET 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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