TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
) N: ~$ j* J# k( w' Z* V" yfrom 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
* W$ M1 ~# G4 ~* T) s+ \; w! T1 Qoverpricing compelled a level of residential construction
+ j7 B2 f/ g5 I- v% e2 S( Zthat exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
* H2 X- J" m5 z; {) I% @three years.
By “overpricing” we mean that prices detached from
+ r; R6 a6 C' j6 L' Ftheir fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
" n- M+ w( a. _6 ^! m/ yboth a cyclical downturn and a return of house prices
4 v* y% S3 ]; V- c! J. M, hto fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
- M6 Q7 j9 ~" C* M- t9 Ewhere 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
+ u5 t/ h( l8 W' Z“overbuilding” was mainly of the first type, where
+ l- h/ G8 q- P# k& r  b$ z/ m# phomebuyers pushed homebuilding to an unsustainable pitch
- x+ E! d! U% k# `8 q8 Pthat is now being rapidly reined in.
* _6 c* t& X8 a) l/ v. UWhile most markets won’t face U.S.-style overhangs,
. ^  w9 a  T; P6 Ithe construction of too many new homes over the boom
" Y+ v# f$ d1 a, d+ P$ Bmeans a deepened slump. This overbuilding will likely weigh
7 t3 E' d6 a( i; pon markets over the next few years. Even as Canada recovers
from the cyclical downturn, house price growth will
; ?; e! ]( H" M3 }2 qremain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
, |+ i4 P5 t/ [; S8 l3 \0 Fis now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
" j# G1 |' M; S" aresidential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
& N. q0 g) O, w2 N# G# Z/ |$ bTo 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
( N6 ]" w) a7 k+ o$ lprovince. Affordability is the key concept behind home
" H7 P! K* q& r) |2 cvalues since house prices should track incomes over the
7 h" L4 R2 T) V, i) ^5 r  B4 g2 Vlong-run. Since homebuilders build to meet demand, we
regard housing prices and household formation as the drivers
  f4 O9 p0 L, y" H( ~7 L; e/ p' K- ?9 O( _: Zof residential construction.
To examine the degree of overbuilding, we employ a
' H% k( w, G* o& m“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
% c7 k9 J1 X7 [  d" yfundamental-justified level by about 12%. Although new
# C3 C" V! T- |5 o7 J7 Z- Kunits were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
1 F; V! L( u0 u. ^4 n/ {Regionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
population 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
' u2 `3 c' f, S/ Sbuyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
6 b1 h. a0 c" O. V4 Y4 j4 B4 i. |weakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
  [$ p7 H$ |: g6 b- hstrange 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
( U; e& \( G- F, [9 X' o1 Urates. While Ontario homebuilding will reel from a
9 t, R/ }# `! {/ H' Ycyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
  V/ \# J4 e3 y8 \condo market. Both in Toronto and Vancouver, historically
" k- _1 I$ W- N8 Shigh levels of apartment-style units presently under
% I2 G# J* Z" j0 }- h; kconstruction mean that record numbers of condos will
+ r, I: E; p) e) k; freach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
# `5 ^- N3 k+ U, k, K5 J# kspike severely – particularly in Vancouver. However, while
$ x" k- U8 v' P2 N; b$ h) D7 ], Presidential 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
+ S1 y) |- H0 a- l! t$ Ryears, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
2 W+ k; f$ ?4 s, AMARKET RETURNS TO FUNDAMENTALS
, X. w6 K" D/ ?* g- _$ vGrant Bishop, Economist
" K& Z* i& W2 w1 s6 ~0 e, |416-982-8063
+ R; a" Z( v2 h) [( X* i; kPascal Gauthier, Economist
416-944-5730

8 x0 b3 P% U' R: |! L; Ihttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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