TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
9 f, S3 [* [  y1 e0 p3 }; Kfrom 2002 to 2008, unsustainable price increases drove
unsustainable levels of building. Our view is that house
: ]- |' I; f1 O' g& o8 W5 \% R- I1 ]prices exceeded the value of housing that was justified by
. d. q# }4 {) m9 Efundamentals by approximately 9% nationwide. This
2 m, l. b/ s7 N; K$ e6 y+ Eoverpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
/ k$ B4 o. h, ~& K1 G- A3 e2 Dthree years.
  H% h7 O( f# \/ I+ G! MBy “overpricing” we mean that prices detached from
  h. W8 I6 b* a2 Ttheir fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
- I5 |: K) ~# gboth a cyclical downturn and a return of house prices
1 z9 E8 z) Z, n- V$ ^; pto fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
+ G" L; V4 |* W8 b/ Mwhere homebuyers buy up too many houses and
& k" T  v( E7 L5 O& E. M6 Sthat this demand cannot be sustained; and “supply-driven”
' t7 U% F) O' K  H4 K+ w& Fwhere builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
! |5 U7 u; [8 z! ghomebuyers pushed homebuilding to an unsustainable pitch
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
/ d5 ^1 N" f. A5 \$ ?: z/ v# B8 Hon markets over the next few years. Even as Canada recovers
from the cyclical downturn, house price growth will
& ]" O. k- [$ L  \; P0 N7 Nremain choppy and new residential construction will be
+ U% X5 G7 H$ @2 Y0 wdampened, owing to this structural weakness. Construction
5 P; R4 ^0 }- U' T4 E7 N0 J* O6 pis now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
9 V  J& G* J# O' z9 i& D# O$ i2 @residential construction will fall further to around
. r+ P& e* a6 f& ^' E* |: j125,000 starts over 2009 with a trough around 115,000 units
. `' [; ^; d, E0 N% Ain the fourth quarter.
2 E7 {( H3 R! wTo quantify the degree of overpricing and overbuilding,
' ~; J; J( d) l  m, ^4 D+ y$ x+ c! w5 {we first develop an empirical model, based on long-run
fundamentals of house prices and housing starts in each
" M1 E5 y/ D# Q" D% S% _# eprovince. Affordability is the key concept behind home
9 P. M2 O2 F4 E/ `+ D8 Tvalues since house prices should track incomes over the
6 ]' X9 X8 |6 E# n5 o: B4 r( `long-run. Since homebuilders build to meet demand, we
, ~5 A# D5 m5 Pregard housing prices and household formation as the drivers
+ r; I, ?" ]# p' M9 V- Vof 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
8 X' L. m+ @0 Z/ r! F  f: n5 k( boptimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
) l: i" B5 P8 e* |7 L; i# Hmany houses at prices that exceeded fundamentals.
( x0 k0 q# u* `* k1 _. KRegionally, we see the greatest strains on the Prairies,
* i( n# K8 ~& awhere housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
2 y9 I( j2 ?& ]already 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
, m- z: V! ~2 ~' ahas been relatively balanced but, while not plagued by structural
weakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
& @$ j0 d1 Q) j' V$ K+ Zstrange accumulation of unabsorbed multiples on l’Île de
/ J; g, q! U/ y# LMontréal – 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
& C0 a4 H, T) V+ kcyclical downturn, the degree of structural weakness appears
; O: n0 s7 d2 t$ I7 H. {2 S9 O% Ylimited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
3 A# c' j- b9 X" p$ D8 O% Uhigh levels of apartment-style units presently under
3 |7 A2 Q. P9 g" y( vconstruction mean that record numbers of condos will
* m1 J9 y, ~2 H6 zreach completion during 2009. If absorption rates fall, as
+ A4 @1 w9 i4 B$ [4 s3 W1 w  Q6 qcyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
/ X$ \% b: k1 h; e( Rresidential construction in B.C. will definitely droop, we
anticipate that the West Coast will continue to benefit from
inter-provincial and international migration over the coming
( |1 _$ n$ b, Gyears, which, along with improvements in affordability,
! _7 v. T, d$ V* s" ?& `- z" }will alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
2 d+ L; S1 u& {MARKET RETURNS TO FUNDAMENTALS
' Y& g7 B! {: e& s# v; BGrant 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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