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
7 H: e/ t0 _) A& D# r: C0 q- Eunsustainable levels of building. Our view is that house
) j* P% i+ A+ r/ nprices 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
" D7 p" I' u. I. X: N+ W) o12%, an excess that was exaggerated in the past
! d. n; B6 m! I! G$ A9 V$ Sthree years.
By “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
6 m9 U: x1 j$ `; P1 y4 j' Eaffordability. The current unwinding of house prices reflects
both a cyclical downturn and a return of house prices
8 _7 C( ~2 A& [* c5 f2 |to fundamentally justified levels.
  T( k+ C, f5 q+ @# IWe consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
/ Q! q6 f! b+ E# J) Nthat 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
homebuyers pushed homebuilding to an unsustainable pitch
2 o" Y$ Q  ]# ~that 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
  p6 g: w/ j$ K3 d* Jon markets over the next few years. Even as Canada recovers
- p1 i: D1 Z; \- f0 Q( F9 n" Ffrom the cyclical downturn, house price growth will
remain choppy and new residential construction will be
$ i" W5 M: y9 Z5 ~$ }dampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
6 u0 e* C& o; T5 b  o1 Y( }to 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
' f) a, Z4 c! G7 P/ @% Nin the fourth quarter.
) @! N' d# W. D- ITo quantify the degree of overpricing and overbuilding,
we first develop an empirical model, based on long-run
( n$ p) s% K7 e9 _fundamentals of house prices and housing starts in each
' i) x+ E0 ~$ @/ m: l* C$ K7 o( iprovince. Affordability is the key concept behind home
7 d0 N% o3 v% k3 k9 Svalues since house prices should track incomes over the
; D8 s6 \) y. _long-run. Since homebuilders build to meet demand, we
9 g& a7 |2 B* Yregard housing prices and household formation as the drivers
of residential construction.
: c8 v( T! g. K9 t/ z1 eTo examine the degree of overbuilding, we employ a
4 K6 ?0 \) d  A4 Y0 ?“counter-factual,” asking what level of residential construction
0 K# X  K4 [- w8 x3 y- ?would have occurred if housing had been priced
* H! X3 {& P( L* w' _optimally. We find that actual homebuilding exceeded this
& d' b6 X5 d( A/ j4 r  \fundamental-justified level by about 12%. Although new
$ r" |) i# a0 o. Y! m/ o9 Y. Y% C$ bunits were being absorbed, homebuyers simply bought too
  h' |8 F2 t1 {many houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
0 J7 Z! M% P  ~* U4 \1 ]where housing demand will further contract under waning
( x" g7 o$ q/ F4 kpopulation inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
3 R  t2 S# O1 {2 I* O9 {! ^very time that the resale market has swung into strong
, }+ j9 T# o4 m  w" \4 I# cbuyers’ territory. Homebuilding in the Atlantic provinces
! p6 z3 G& Y" t2 }9 J, Rhas been relatively balanced but, while not plagued by structural
5 i) h# k1 y1 p; E; `$ {% s  q4 mweakness, will be singed by the downturn nonetheless.
1 f+ I/ p, P& Y0 Q2 u( MQuébec shows signs of strain – especially given the
8 y+ D6 p8 E+ W8 _9 R+ Mstrange accumulation of unabsorbed multiples on l’Île de
9 \- D' z  ]% x4 C1 a* g* Q* oMontréal – 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
( |1 N5 k( J6 ]( climited – with the important exception of the Toronto
- w4 a" M" H/ ]- Fcondo market. Both in Toronto and Vancouver, historically
( S6 I( [; P1 R+ G+ zhigh levels of apartment-style units presently under
construction mean that record numbers of condos will
$ i6 O) L* O7 f' p; hreach completion during 2009. If absorption rates fall, as
6 {) t/ x' A; _' dcyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
5 T. B! q. i4 Dresidential construction in B.C. will definitely droop, we
5 ^/ k" b# }9 ^; @anticipate that the West Coast will continue to benefit from
inter-provincial and international migration over the coming
+ y$ ~: I: M6 g- @years, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
- E- ?$ p0 _* o8 Y+ g. dOVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
. N! r( ]; w) S9 Z& kGrant Bishop, Economist
; j% c  G, N& u' o2 h% b& H/ O% R416-982-8063
& W1 S# ?) n3 v9 s8 \Pascal Gauthier, Economist
416-944-5730

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

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