TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
( y, i' O3 L- m7 J" m6 s3 E' xfrom 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
& W: ]* b6 i( t; Q  B# Ithat exceeded its fundamental-justified level by approximately
9 J3 }- j9 ^4 `2 y% O9 J* K6 W12%, an excess that was exaggerated in the past
- C- i0 u* Z0 W' h! m, e  Tthree years.
By “overpricing” we mean that prices detached from
. k" I, b+ n- Y& M- q( W! Etheir fundamentals, as witnessed by a steep erosion of
9 q8 X: r: W2 M6 k4 J1 v! A. vaffordability. The current unwinding of house prices reflects
both a cyclical downturn and a return of house prices
* I7 H' T& r7 M7 j+ ?" Ato fundamentally justified levels.
! a; A8 n2 a1 F% p$ h; a2 CWe consider “overbuilding” of two forms: “demanddriven”
" w  o: O0 _9 l2 L6 Vwhere homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
4 t3 }, Z0 F" D" x8 F' s' Z, Dwhere builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
2 y  |4 V4 T2 ]homebuyers pushed homebuilding to an unsustainable pitch
# R2 g% {' e' s! s. z% Tthat is now being rapidly reined in.
; o, D  j/ o2 y8 _* V; e( AWhile most markets won’t face U.S.-style overhangs,
" w! s0 n3 [9 b2 Y" `1 dthe construction of too many new homes over the boom
' \; G# u9 X" \means a deepened slump. This overbuilding will likely weigh
on 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
is now undershooting fundamentals and we expect this
. o' J$ ]0 E1 \! G2 d  mto persist over 2009 to 2011. We anticipate that nationwide
; A' H" [" u& u1 f5 L3 M6 eresidential construction will fall further to around
( t' w8 }1 R$ f. ?. C125,000 starts over 2009 with a trough around 115,000 units
+ N% a3 n4 ~0 R/ ]( K4 u/ ^in the fourth quarter.
2 Z" u+ [" C6 Q) N3 r- H, \To quantify the degree of overpricing and overbuilding,
we first develop an empirical model, based on long-run
fundamentals of house prices and housing starts in each
! _' {6 M- r; e/ Q% m1 q1 b) [province. Affordability is the key concept behind home
values 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
' U# N8 a! R4 {of residential construction.
To examine the degree of overbuilding, we employ a
+ H! _8 K1 ~; j3 X9 {“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
. D* n8 U- j9 p  c8 k/ M2 r4 ]- S) xoptimally. We find that actual homebuilding exceeded this
* }7 e- H# \- efundamental-justified level by about 12%. Although new
- e. Y3 w; I9 c. o# U& bunits were being absorbed, homebuyers simply bought too
! w7 e5 n- N6 n1 q9 bmany houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
. j  U* b: F/ @1 p7 Awhere housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
/ F- L. j7 z& x2 Q5 A) talready witnessing surges in their unsold new homes at the
very time that the resale market has swung into strong
4 N- B1 c/ n/ _/ qbuyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
) V2 \+ _3 P$ L9 ^9 ?weakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
* |8 I/ N& s% I) u9 sstrange accumulation of unabsorbed multiples on l’Île de
6 H& x/ g8 ?3 T/ M; n" jMontréal – 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
limited – with the important exception of the Toronto
# A" J; ^& W) Xcondo market. Both in Toronto and Vancouver, historically
3 {) W, ^. w0 o. l# Xhigh levels of apartment-style units presently under
6 z9 f6 Y! R3 z! N5 ]construction mean that record numbers of condos will
* {, E  p1 N5 _7 r' z, mreach completion during 2009. If absorption rates fall, as
/ X  E. R9 x. s& `. a+ g% [cyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
3 _4 F- }$ j$ o4 ~5 Zresidential construction in B.C. will definitely droop, we
anticipate that the West Coast will continue to benefit from
: o" U+ Z1 X" v' A$ j- Y6 h* g( @inter-provincial and international migration over the coming
years, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
/ X8 Q( J% Y2 [5 T+ QMARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
. a1 z. u: u5 I! B% }416-982-8063
Pascal Gauthier, Economist
416-944-5730
* o2 G- X, K$ _* r
http://www.td.com/economics/special/gb0409_housing_exec.pdf

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