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
9 e, V! b. j/ Z9 F- _0 M5 Xprices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
; O6 i+ G: b" U( H# z) |: roverpricing compelled a level of residential construction
: i6 k7 r: q6 M9 z" I" S% Rthat exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
3 m# H( b7 X& q+ y9 nthree years.
! H# c( ]  Z( z4 G( E, |7 ]! KBy “overpricing” we mean that prices detached from
6 o- M' }4 w2 n1 d( @: vtheir fundamentals, as witnessed by a steep erosion of
# c6 y0 ^5 c. a5 vaffordability. The current unwinding of house prices reflects
1 u5 l7 @9 A+ Y3 w1 [both a cyclical downturn and a return of house prices
/ }8 e4 p* p& p4 rto 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”
9 f5 H: d  d% @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
& v0 w0 v. ]. M$ G( `homebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
7 S+ S1 b1 D' [+ I& yWhile most markets won’t face U.S.-style overhangs,
8 N9 f$ \/ O; h( a$ S& a0 ^" |; Uthe construction of too many new homes over the boom
# n) D  ~( u; @& l; x4 S& Fmeans a deepened slump. This overbuilding will likely weigh
, G6 A' K0 B% ^3 hon 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
dampened, owing to this structural weakness. Construction
5 X. s  s1 _8 }; o4 D- _is now undershooting fundamentals and we expect this
, ^. [! `  M5 R" Nto 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.
" K3 v: s1 h; ATo quantify the degree of overpricing and overbuilding,
: D1 H' ^: w! X) z1 S) X! T8 x  Nwe 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
* I0 M6 s* c& m  p0 |values since house prices should track incomes over the
% t/ A& a0 [+ t+ i8 }& elong-run. Since homebuilders build to meet demand, we
regard housing prices and household formation as the drivers
& r3 w! m% d9 [, ~of residential construction.
To examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
4 A$ F& D( D2 U- P  H" [# |2 Kwould have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
8 L+ W/ ]; |) a! x$ [2 e0 Y" Efundamental-justified level by about 12%. Although new
1 x9 w$ H* n7 B, r5 Zunits were being absorbed, homebuyers simply bought too
- P" _1 A0 S$ M" m9 L& {3 Zmany 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
7 v! o' y& a+ Qalready 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
" U( _) v, V6 p: J0 V8 g- Zweakness, 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,
" y9 Z" i  a+ t1 R& T8 Ggiven the province’s history of under-building and low ownership
rates. While Ontario homebuilding will reel from a
9 Q! n, {. }# {: h6 Y8 ~& Ucyclical downturn, the degree of structural weakness appears
" E+ U$ m/ B0 ^limited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
3 s0 {- G( h% ]high levels of apartment-style units presently under
3 K+ _  E( G" J7 L8 Oconstruction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
3 x: _1 ~* T7 Z$ c' h1 d, c) m: }cyclical factors would indicate, condo inventories could
, M/ V4 |/ l/ k' _spike severely – particularly in Vancouver. However, while
residential construction in B.C. will definitely droop, we
' ?1 n. t. D7 b- Uanticipate that the West Coast will continue to benefit from
# _( s' j% V6 {/ f) k5 R  N$ cinter-provincial and international migration over the coming
years, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
: `' {) ?7 I4 N' ~. L$ bOVERPRICED AND OVERBUILT: CANADIAN HOUSING
/ v; w' m8 Y  D6 r+ VMARKET RETURNS TO FUNDAMENTALS
2 }( @( {  V( b2 VGrant Bishop, Economist
416-982-8063
Pascal Gauthier, Economist
* L# S# e( e  A' F8 k416-944-5730
0 d1 R1 |" C& n/ e9 S  ^1 }
5 h* v! z: w$ b- chttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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