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
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
" v4 d+ J  W  p6 _  j3 B  K/ f5 voverpricing compelled a level of residential construction
& S: ~9 E, e$ F" |1 Cthat exceeded its fundamental-justified level by approximately
! L6 T" w. i+ F( J; ^8 J12%, an excess that was exaggerated in the past
1 m" S+ a1 G+ C- t9 Y/ c! d6 ythree years.
- J- `' @+ _$ L" _$ [+ h# S4 JBy “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
both a cyclical downturn and a return of house prices
# V" U' V. L2 C1 Jto fundamentally justified levels.
7 |4 x0 Y9 p6 `, w  cWe consider “overbuilding” of two forms: “demanddriven”
/ A6 D, b$ d# s' O) v5 t& @where homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
" j' T" u( m1 z8 ~2 t7 ?“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
. P0 y$ D& m. z  sthe construction of too many new homes over the boom
; r+ ]6 f" s. l1 ]0 _: emeans a deepened slump. This overbuilding will likely weigh
' H. L  t8 U' aon markets over the next few years. Even as Canada recovers
& O8 b7 L- |6 n; c! T8 M/ `from the cyclical downturn, house price growth will
+ e* R2 r' T' ~8 [% P5 ~) ~  Xremain choppy and new residential construction will be
# t8 K( [% c% |  H9 ]- ~% Udampened, owing to this structural weakness. Construction
' c( C, v. ^. }is now undershooting fundamentals and we expect this
& \* f  T+ ~6 U- C% X$ k& e+ mto persist over 2009 to 2011. We anticipate that nationwide
2 Z. k4 a. z4 v: i; I- {6 cresidential construction will fall further to around
  ~1 @9 {& c, e* J125,000 starts over 2009 with a trough around 115,000 units
4 G2 X2 B. O2 l2 B$ E% g0 ~in the fourth quarter.
$ K2 M( O& T" KTo 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
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
* t7 q7 R- o- ]; z, d+ t4 nof residential construction.
- b8 A+ k- X* P6 G  k+ c% ?To examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
: N4 H! L, v4 b- Nwould have occurred if housing had been priced
5 ~; a( A' I. R3 m& }optimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
# A$ }( `4 a7 O8 B$ i) C+ imany houses at prices that exceeded fundamentals.
8 H% Z2 Y+ V, k# VRegionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
* e2 r/ ^3 E4 j8 |- ~; tpopulation 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
/ G' O4 o& h5 E& _weakness, will be singed by the downturn nonetheless.
5 [- _  V* Q# j2 T$ @/ ?' V0 H1 Y, q: cQuébec shows signs of strain – especially given the
  F1 B- e$ P9 L7 y, E, m/ j/ xstrange accumulation of unabsorbed multiples on l’Île de
) N4 }- G$ h1 a) d3 qMontréal – but recent building has been relatively balanced,
2 |7 e4 S) u8 Ggiven the province’s history of under-building and low ownership
rates. While Ontario homebuilding will reel from a
- I9 ]! p, U8 w1 Z  ?/ {" M1 [cyclical downturn, the degree of structural weakness appears
; b& b% o  Y' U) _6 Zlimited – with the important exception of the Toronto
6 K/ r8 D; R0 t/ C; `. ^& T9 Xcondo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
construction mean that record numbers of condos will
0 P! j# f1 [4 r" e9 Ereach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
1 ]) U1 w2 Z% N3 t) X' Oresidential construction in B.C. will definitely droop, we
anticipate that the West Coast will continue to benefit from
5 C  |; ?  b+ g, A( s# finter-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
MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
* w% N' p3 o6 c2 D; h416-982-8063
Pascal Gauthier, Economist
$ s7 i) N7 |) U4 T+ x/ g$ `) ^416-944-5730
& l9 I+ W6 X9 `+ a+ m0 R1 M  R
http://www.td.com/economics/special/gb0409_housing_exec.pdf

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