TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
2 z: o7 e7 ~% M) rfrom 2002 to 2008, unsustainable price increases drove
unsustainable levels of building. Our view is that house
# W, j+ x4 r" F1 `( r$ Yprices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
  y- I: W2 T% C" e  Z' f+ F3 Coverpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
three years.
By “overpricing” we mean that prices detached from
5 ]3 Q  e3 c# N$ Ltheir fundamentals, as witnessed by a steep erosion of
; m' I2 s; v  c" E- ]2 \affordability. The current unwinding of house prices reflects
* @% N$ V. B9 P; }' I, aboth a cyclical downturn and a return of house prices
to fundamentally justified levels.
4 ]' {8 o9 c( zWe consider “overbuilding” of two forms: “demanddriven”
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
“overbuilding” was mainly of the first type, where
) m3 w) j* Y: x/ Hhomebuyers pushed homebuilding to an unsustainable pitch
$ P* _& A/ R! y9 [/ P! h8 c% ythat is now being rapidly reined in.
2 }  Z0 M* {5 j9 t  n9 `1 wWhile 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 o9 W5 e9 J/ u5 Q2 s6 ]5 Ion markets over the next few years. Even as Canada recovers
3 _6 i; j  [6 w2 \( F1 }from the cyclical downturn, house price growth will
remain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
* F) D- ^( s1 m- E6 X0 L* _3 `is now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
2 D7 }  C! D4 Z, x' g( o' wresidential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
. X1 V. X. o7 D$ j) H. @in the fourth quarter.
To quantify the degree of overpricing and overbuilding,
' @) {0 g7 W  o( Cwe first develop an empirical model, based on long-run
fundamentals of house prices and housing starts in each
2 ~8 p, L$ y. B% M) Fprovince. Affordability is the key concept behind home
values since house prices should track incomes over the
9 w+ C7 A: z" Klong-run. Since homebuilders build to meet demand, we
/ P( g! Q- A" kregard housing prices and household formation as the drivers
' y% p9 f* z, `5 i' L$ oof residential construction.
/ b' J5 a" k+ u. k+ tTo examine the degree of overbuilding, we employ a
6 e0 k6 d% ]2 Y! B$ J1 w9 C9 J“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
6 N, m5 a# R% L( ffundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
. }8 p2 Q* Q+ K7 R8 U1 m/ c$ D: hmany houses at prices that exceeded fundamentals.
) D! g4 L, M1 j: K4 dRegionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
# h1 h6 N0 L+ [population inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
7 B( z2 ~  n' A9 v/ V/ _9 Qvery 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
weakness, will be singed by the downturn nonetheless.
, P5 m# j& b5 S' O) ^6 \1 gQuébec shows signs of strain – especially given the
" h* r' i% \3 t% a& c* ^/ k" jstrange accumulation of unabsorbed multiples on l’Île de
  w: n; W5 G  _/ ~Montréal – 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
' Q/ a& K5 o- [. m, Zlimited – with the important exception of the Toronto
6 V: h! X8 F3 L! F' i* s5 P4 vcondo market. Both in Toronto and Vancouver, historically
( A+ }& X* `2 C/ s% N4 Ihigh levels of apartment-style units presently under
+ T0 ~3 L# V# \0 _3 w( Kconstruction mean that record numbers of condos will
- P2 U# E; C: L  y8 @reach completion during 2009. If absorption rates fall, as
, L3 h. T' w( ]5 Y4 r, }cyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
4 |2 [% P9 M2 N- Rresidential construction in B.C. will definitely droop, we
( @: j/ Y+ N1 j/ ?  V- Oanticipate that the West Coast will continue to benefit from
inter-provincial and international migration over the coming
  |1 S- h# f7 I/ Q! {; U8 d, Pyears, which, along with improvements in affordability,
( F8 p% F3 v3 ?5 Swill alleviate some of the pressure from overbuilding.
4 P2 Q) s# e  Z& m5 Y- u2 n. |& p. BOVERPRICED AND OVERBUILT: CANADIAN HOUSING
  s+ g+ e* F4 P/ {# W( fMARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
( _& c: {% g  u1 ?& B$ K* z7 C, l4 }416-982-8063
1 L+ b! O( t( u! C* ^/ hPascal Gauthier, Economist
416-944-5730
/ R( Y- i( ^7 _
! c; @4 V* a3 O9 C: d/ C$ @) Zhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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