TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
& X" ^; F. d* f3 ]from 2002 to 2008, unsustainable price increases drove
unsustainable levels of building. Our view is that house
prices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
4 o3 }  ^* f$ e1 R$ Fthat exceeded its fundamental-justified level by approximately
! P) \( x5 ]7 d, _- D12%, an excess that was exaggerated in the past
three years.
# J0 P$ H) b0 e5 H0 gBy “overpricing” we mean that prices detached from
3 |& Z( y* `  Q/ q3 C5 i1 wtheir fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
3 y: i& X' R! J" S% n5 Fboth a cyclical downturn and a return of house prices
- V1 U. J3 H/ A3 Q0 M: g- [to fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
9 m3 @& q, l1 y' U5 u$ Q, K1 Awhere homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
9 _0 E, ?1 V+ M+ J1 {where builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
' f0 k) d% q8 y, s& p“overbuilding” was mainly of the first type, where
0 ?9 q$ D5 `* }+ |1 v1 ~homebuyers pushed homebuilding to an unsustainable pitch
% f8 d- [& n5 `$ q6 athat is now being rapidly reined in.
) t% D6 U* G9 mWhile 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
4 \9 T8 T( C/ z% ~9 X6 U' c. Q* zon 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
; @% M  Y+ ~7 p7 R! Z5 L9 ~. y" Tdampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
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
in the fourth quarter.
) ~, ?2 n, `' \' V: n2 `4 S2 wTo quantify the degree of overpricing and overbuilding,
2 i3 X. j. Z8 b. e& Mwe first develop an empirical model, based on long-run
* S! k, Q6 b  ofundamentals of house prices and housing starts in each
$ @+ {$ m$ G+ u2 Pprovince. Affordability is the key concept behind home
values since house prices should track incomes over the
+ W: {. I; [0 X1 \$ |2 _+ ~  Qlong-run. Since homebuilders build to meet demand, we
8 ^) h# v9 ~: H0 B! B! tregard housing prices and household formation as the drivers
of residential construction.
To examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
* m5 D7 }2 S' e  ^would have occurred if housing had been priced
- z3 _' A8 [5 O# qoptimally. We find that actual homebuilding exceeded this
5 L( v6 c  g6 ]2 X$ N9 ufundamental-justified level by about 12%. Although new
" D( S8 D: v8 j7 aunits were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
% u) D5 P$ ]1 W" T5 @2 R3 URegionally, we see the greatest strains on the Prairies,
+ C9 i) \7 ^. _1 kwhere housing demand will further contract under waning
) W0 T; A; w/ B$ B* K- {7 ipopulation inflows. Saskatoon, Calgary and Edmonton are
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
has been relatively balanced but, while not plagued by structural
weakness, will be singed by the downturn nonetheless.
5 u$ O; x$ R1 j+ w4 iQuébec shows signs of strain – especially given the
strange accumulation of unabsorbed multiples on l’Île de
Montréal – but recent building has been relatively balanced,
* @+ `# F1 t  V* F/ Y* Ugiven the province’s history of under-building and low ownership
- ]  n, r/ B* Q! p& Prates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
5 B5 L# J. ^% J9 Y. C% ~# Tlimited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
1 C3 u. Z1 m9 O/ z7 j7 _. Yconstruction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
; P4 J# r- @. t8 S9 }: u7 I# s: `cyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
* p% j  a( D6 a; `4 Xresidential construction in B.C. will definitely droop, we
8 C7 s  |) z6 R  Y+ |) }anticipate that the West Coast will continue to benefit from
  B/ l/ U" F0 V7 g1 v6 \inter-provincial and international migration over the coming
years, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
# w* G( ]8 c# e+ o; g5 {2 |5 }OVERPRICED AND OVERBUILT: CANADIAN HOUSING
' U* P8 h  q' v( y3 {, [MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
9 ~1 O$ j' o& }, t, j416-982-8063
; a1 W) H  `! n6 oPascal Gauthier, Economist
; i9 A& v, o8 q; S7 Y5 c  d2 q1 R416-944-5730
6 {6 X4 x- r3 _% H
http://www.td.com/economics/special/gb0409_housing_exec.pdf

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