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
; i) ~: d. V9 k1 l& T* k) E: J) D% A3 ^prices exceeded the value of housing that was justified by
* I% `/ R% y1 k8 s2 a2 h0 nfundamentals 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.
By “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
' n  i" O1 _* ?; ]both a cyclical downturn and a return of house prices
% g& V1 ^1 H7 R' I" Uto fundamentally justified levels.
6 ]6 [- @# C8 ]- u8 }! mWe 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
' z+ h* d0 S9 ]$ P“overbuilding” was mainly of the first type, where
( B6 G5 F  J  p! G" ^homebuyers pushed homebuilding to an unsustainable pitch
4 m3 n" m$ ^. b. jthat is now being rapidly reined in.
) ]2 O( o, F- @8 a+ v% R* OWhile most markets won’t face U.S.-style overhangs,
/ d  H! a, r& O/ j& L$ Qthe construction of too many new homes over the boom
, p  n; @0 t  e# f& ^: ~  r) `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
0 f! k+ l9 q% Yremain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
2 w5 y$ l6 x- w' _* I8 dis now undershooting fundamentals and we expect this
  U$ x& G  K7 t0 r- t4 c& o: `2 Nto persist over 2009 to 2011. We anticipate that nationwide
, Z9 o! M8 d1 S6 zresidential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
1 u" w. l/ W( Y6 o. ]5 T; S) tin the fourth quarter.
To quantify the degree of overpricing and overbuilding,
we first develop an empirical model, based on long-run
9 s% F( r- p. S2 T2 q# g. ?! I7 K/ ifundamentals 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
long-run. Since homebuilders build to meet demand, we
regard housing prices and household formation as the drivers
of residential construction.
0 I0 y8 Z8 h; Q# j' {. YTo examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
1 M9 [% F1 R' B% j) S3 k, ?would have occurred if housing had been priced
. o: ^6 V% p3 r1 _4 Soptimally. We find that actual homebuilding exceeded this
) ^3 S+ }3 k+ m+ I5 qfundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
1 }; J/ |  O5 U+ G% r: I5 p0 Y: vRegionally, we see the greatest strains on the Prairies,
$ ]) k* z3 Y, S- @where housing demand will further contract under waning
) C+ K9 {" `+ T6 T' y7 F* Dpopulation inflows. Saskatoon, Calgary and Edmonton are
4 I3 x2 J+ W1 s+ Lalready witnessing surges in their unsold new homes at the
$ V7 P7 N& V) D% K- ^# B  L1 zvery time that the resale market has swung into strong
buyers’ territory. Homebuilding in the Atlantic provinces
8 o" j0 ^* S7 D  ehas been relatively balanced but, while not plagued by structural
weakness, will be singed by the downturn nonetheless.
5 P/ R# R8 {: a1 [  l+ ?( TQuébec shows signs of strain – especially given the
2 ^& Z1 C% ^0 mstrange accumulation of unabsorbed multiples on l’Île de
; U$ @2 W6 R1 G: A: yMontréal – but recent building has been relatively balanced,
6 B# Y5 @, }. a" Y8 V$ egiven the province’s history of under-building and low ownership
* M$ n. Q7 Q9 v9 \  m# ^$ grates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
  Q, L7 d& A$ V# r7 w8 n2 scondo market. Both in Toronto and Vancouver, historically
) X; |6 i9 a6 Q9 C9 R9 ?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
cyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
! V% [' ^2 A$ w  Z: Lresidential construction in B.C. will definitely droop, we
anticipate that the West Coast will continue to benefit from
/ B! ^4 `* ]+ x2 C; q0 ?( J2 Hinter-provincial and international migration over the coming
4 u" V) z9 L4 X; q( R& R' W) m4 Cyears, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
5 q% C* e. G; w) y$ d. H# l, \" @" ^MARKET RETURNS TO FUNDAMENTALS
- ]# R% ?8 i! N# ^7 [; JGrant Bishop, Economist
3 I- ?) Q3 d/ c. m, t416-982-8063
Pascal Gauthier, Economist
416-944-5730

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

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