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
5 u" y9 i8 u7 u) ?" E: \1 N0 Pfundamentals by approximately 9% nationwide. This
" }& V; F8 {4 uoverpricing compelled a level of residential construction
" o) G/ _0 j) ?2 w7 Mthat exceeded its fundamental-justified level by approximately
  |2 T1 {  q5 P' V3 C12%, an excess that was exaggerated in the past
3 t8 B+ i: |- c! }' Jthree years.
By “overpricing” we mean that prices detached from
7 l$ y/ l* K! ctheir fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
+ q  v4 o: V6 a; T% j0 Z% Gboth 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
0 ]* a8 h) S/ y6 d2 \" Z, v) Kthat this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
. s" T7 |6 }* H- n8 a) W, Bthere is evidence of both types, we contend that Canada’s
+ G7 g: t3 L; @2 _“overbuilding” was mainly of the first type, where
- D, g) r" Z' _# y/ _+ khomebuyers pushed homebuilding to an unsustainable pitch
- y# c+ s3 ?6 G. c) G# d9 Ithat 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
on markets over the next few years. Even as Canada recovers
  [! h$ t0 N& o' m2 rfrom the cyclical downturn, house price growth will
" ~0 f' ]; u4 j8 P, N- hremain choppy and new residential construction will be
6 }. e/ D5 j! h! I9 Z7 Cdampened, owing to this structural weakness. Construction
, q$ z9 P2 H5 U9 R1 his now undershooting fundamentals and we expect this
9 i  Y  Y$ j- F8 F6 ]to 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
in the fourth quarter.
& Q2 u$ M- ?9 ]$ S& I5 M2 I( Y3 TTo quantify the degree of overpricing and overbuilding,
# Y' J! l$ l) m( ]  x" _we first develop an empirical model, based on long-run
1 B) C8 [! [* X3 Mfundamentals of house prices and housing starts in each
province. Affordability is the key concept behind home
* z. G( M/ \( }) `  X6 }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
, }& X$ x6 R# L( xof residential construction.
To examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
+ S% p; D# `1 [optimally. We find that actual homebuilding exceeded this
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,
where housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
& _1 l4 ~8 E7 ?7 p" Q) B- j8 E* Ialready witnessing surges in their unsold new homes at the
& t, n. c2 J6 @; R" c  lvery time that the resale market has swung into strong
& V: e3 y5 O* q" D; K/ Gbuyers’ territory. Homebuilding in the Atlantic provinces
: k  y* i  i( A( @( f. ~has been relatively balanced but, while not plagued by structural
/ d% t, ?& N7 P" H% V" |weakness, will be singed by the downturn nonetheless.
. b1 i8 _% [1 ?  |) JQuébec shows signs of strain – especially given the
strange accumulation of unabsorbed multiples on l’Île de
Montréal – but recent building has been relatively balanced,
, k3 d8 D6 ?4 f* d" a1 {7 xgiven the province’s history of under-building and low ownership
5 r' O) V1 h9 d0 Zrates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
& Q, m& E. Y: q# [  ~limited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
" Y# j& a/ w7 I) P. s1 }construction mean that record numbers of condos will
- k7 u' o: a) e5 l& T% w: r" Creach completion during 2009. If absorption rates fall, as
/ w. W. I7 ~7 F$ M7 y" _& jcyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
% ]/ G3 i+ h+ L, V# G+ {( b5 cresidential construction in B.C. will definitely droop, we
anticipate that the West Coast will continue to benefit from
# a7 }3 k6 t! |' n2 P% ^: f/ finter-provincial and international migration over the coming
& G/ A: _2 g+ D6 n+ L9 \years, which, along with improvements in affordability,
1 \/ G1 T* |9 E, l& @; X: N9 |will alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
; k& g! N7 y1 MPascal Gauthier, Economist
416-944-5730
# u% q" T& L! `, K
http://www.td.com/economics/special/gb0409_housing_exec.pdf

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