TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
" Q8 [2 |2 z0 |" e+ Q$ v  wfrom 2002 to 2008, unsustainable price increases drove
$ j$ i3 p6 l- e- X( T& Nunsustainable levels of building. Our view is that house
  _% W5 a5 k/ y1 p7 D1 Vprices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
3 x! q* N  H. z# V) }0 F. Zoverpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
3 s9 m! s7 m# r6 C2 o% o12%, an excess that was exaggerated in the past
/ U% z0 J9 ~6 H4 ?three years.
By “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
6 R' I1 |0 [  U& e& ^affordability. The current unwinding of house prices reflects
both a cyclical downturn and a return of house prices
to fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
7 U9 O' e8 g5 t2 Bthat this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
) J3 I( K- J/ f) @0 T* qthere is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
9 g; ?+ q1 ?# v0 e" \3 d3 u" hhomebuyers pushed homebuilding to an unsustainable pitch
* ^& c: l- e5 Z- W6 ]& s+ ^: O3 Othat 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
6 v8 v" L2 k9 oon markets over the next few years. Even as Canada recovers
" r/ v* {+ {& J! Dfrom the cyclical downturn, house price growth will
remain choppy and new residential construction will be
9 v" a, s# I- i. |) V' Idampened, owing to this structural weakness. Construction
/ e) r" n6 n; G  _is now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
7 k7 F! d/ A  i  U8 @residential construction will fall further to around
* O7 J' ?- p8 ~125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
: Y. \! ?; T& |5 P5 GTo quantify the degree of overpricing and overbuilding,
' U0 q3 ~* V* t: ?8 w8 U0 Lwe first develop an empirical model, based on long-run
4 X4 N  F8 N% P5 K0 p( N4 S0 vfundamentals of house prices and housing starts in each
( I- h0 D3 Y, l9 I2 e2 k( wprovince. 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
of residential construction.
To examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
2 x8 {" f9 [: ^. M, ewould have occurred if housing had been priced
2 \: q9 m; W0 r/ woptimally. We find that actual homebuilding exceeded this
2 W3 h1 n& y7 Y' a0 [& c2 R3 _& o9 ~fundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
! N$ r4 s0 @: R" Rwhere housing demand will further contract under waning
! p! P) Y' m8 I9 r) wpopulation inflows. Saskatoon, Calgary and Edmonton are
' F! Y3 ~$ `! ^0 Kalready witnessing surges in their unsold new homes at the
very time that the resale market has swung into strong
( ~+ a. N6 I8 v7 s1 P! G0 Xbuyers’ territory. Homebuilding in the Atlantic provinces
has 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
strange accumulation of unabsorbed multiples on l’Île de
Montréal – but recent building has been relatively balanced,
given the province’s history of under-building and low ownership
$ S3 r, {$ s5 s& n! k' rrates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
* Z4 i+ P: K) c3 J  U. B: Yhigh levels of apartment-style units presently under
: l" _3 i6 t2 r4 v% n) Nconstruction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
' }  B5 ^. V: D8 c/ |1 \spike 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
inter-provincial and international migration over the coming
! R+ C& `. b; D& h# }, v( yyears, which, along with improvements in affordability,
! ~: t3 T: z8 ~6 s" y7 Vwill alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
2 a, s) s$ i& F- q8 {MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
Pascal Gauthier, Economist
; q' L9 W; ?  _6 v5 V( S416-944-5730

4 ]8 d' Y8 I$ M; F- I6 fhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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