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
1 {* e1 g9 O3 F& ounsustainable levels of building. Our view is that house
prices exceeded the value of housing that was justified by
7 l& M0 m, Z' U* mfundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
: S7 i) {: R$ G+ {" wthat exceeded its fundamental-justified level by approximately
% U; Z9 E& r2 T1 k' b. T8 E12%, an excess that was exaggerated in the past
3 I: O8 w7 L# }5 n3 Zthree years.
By “overpricing” we mean that prices detached from
" g9 K4 r$ Z' z( Y4 O- A3 e% ntheir fundamentals, as witnessed by a steep erosion of
/ f: r9 X0 p5 H3 `6 @* b3 }affordability. The current unwinding of house prices reflects
2 h5 A. V  ^! L9 j$ o3 xboth a cyclical downturn and a return of house prices
" y' n! n7 X# D3 A: e* z# Hto fundamentally justified levels.
  }7 R( K; l) N, _. n( pWe consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
8 p; z1 x) K' j+ f% P2 Othat this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
& ?$ Q2 H: S7 h) N# H2 _there is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
# A  d) p: G4 zhomebuyers pushed homebuilding to an unsustainable pitch
0 O8 @! y: O8 H- j' v$ W% t6 jthat 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
- R0 ]) R: x, P# H8 jon 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
9 T0 K2 b4 g+ Kis now undershooting fundamentals and we expect this
. u' C* ^- m8 i5 Pto 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
1 G7 }* y, U/ ^2 Cin the fourth quarter.
6 {0 _- o4 ~3 P, D. C1 {4 _To quantify the degree of overpricing and overbuilding,
. j2 J2 K9 J4 |! ywe first develop an empirical model, based on long-run
# }3 d* c( N0 s; Ffundamentals of house prices and housing starts in each
province. Affordability is the key concept behind home
- w9 F/ J* f9 V* uvalues 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 T  [9 d6 @- b+ W( BTo examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
  ?! w, e' V3 N5 m+ X5 A: r' owould have occurred if housing had been priced
& ?' q8 \6 {# Z8 O7 b9 c. B6 j1 J; x; Goptimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
# W# e* j" J1 Q, P  Iunits were being absorbed, homebuyers simply bought too
) ~! t2 i3 N' l! Nmany houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
0 E* S! F0 @) L, O% fpopulation inflows. Saskatoon, Calgary and Edmonton are
# I8 }/ ^+ N  l& \; K6 jalready witnessing surges in their unsold new homes at the
0 n, F9 z( d! Z7 n) h+ S, mvery 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
6 P# ~+ _6 q  J+ S, Uweakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
8 e, m: @& W; S6 {3 |+ d0 gstrange accumulation of unabsorbed multiples on l’Île de
Montréal – but recent building has been relatively balanced,
& {7 C: m3 \1 E  f9 ~given the province’s history of under-building and low ownership
5 e4 P  n  H9 X+ g. xrates. While Ontario homebuilding will reel from a
# ?& g# g( q- l/ zcyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
; O8 G9 g* Z( m8 S- y1 S+ {/ x4 Uconstruction mean that record numbers of condos will
* i8 l" P* o9 l% L; Q$ u/ ?reach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
3 f1 |' {$ w* }; t7 F( D: N3 Vspike severely – particularly in Vancouver. However, while
residential construction in B.C. will definitely droop, we
anticipate that the West Coast will continue to benefit from
7 a  h. B5 ]! Y! Tinter-provincial and international migration over the coming
! T. ]& _! @& C: V' _years, which, along with improvements in affordability,
5 k& m0 P; w! Z7 b3 k* f$ ewill alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
' K: y* b' d( J% w9 M/ i" cMARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
: H+ |7 W9 Q! G( o; O, G416-982-8063
* U% u- c% g( y: g. CPascal Gauthier, Economist
416-944-5730
% e2 \1 r6 Y5 R0 m1 r7 c( ?
! J, T: A* c, N! E$ p* Xhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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