TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
% f1 O. r+ p& A* Hfrom 2002 to 2008, unsustainable price increases drove
; L6 ?6 v' G* sunsustainable levels of building. Our view is that house
, L- w# V0 j' P; v% a$ g+ a3 M( rprices exceeded the value of housing that was justified by
* u. ~! z+ y9 Rfundamentals by approximately 9% nationwide. This
5 Y0 e% Y- O8 woverpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
2 H8 v; \& D1 v: Q# @* A12%, an excess that was exaggerated in the past
% J( `( ?2 z. ~+ L  i4 q  xthree years.
6 c0 t, T7 j  C6 iBy “overpricing” we mean that prices detached from
  D' a: ~  d; e# M& q0 B, D7 R( xtheir 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
to fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
7 Q/ E4 t, p2 Y2 e9 w, {where homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
( b2 m/ h/ H; K: Mwhere builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
8 v1 T" e. `$ Y“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,
3 o* ]  q/ @7 f  ]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
from the cyclical downturn, house price growth will
$ k# Z: h" z4 ~4 `7 o1 |remain choppy and new residential construction will be
0 U# S+ d9 X( Y# h" Kdampened, owing to this structural weakness. Construction
8 e: U# q2 N% P) D$ N9 l$ ~is now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
/ y% d- K- _8 Eresidential construction will fall further to around
" E) b' s1 _+ t8 _. p/ V1 I125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
To quantify the degree of overpricing and overbuilding,
0 N, h6 X# K7 P! @we first develop an empirical model, based on long-run
fundamentals of house prices and housing starts in each
! u) P( E: m; w# Y/ n! C. dprovince. 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
7 M: H3 S6 D5 \  H" Uof residential construction.
2 h, W5 @7 `, i6 H3 O# A" lTo examine the degree of overbuilding, we employ a
+ c- P* t0 F5 H+ Z. F“counter-factual,” asking what level of residential construction
1 i5 T2 k4 E# ~& K2 Rwould have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
5 p/ b0 r" I1 h' efundamental-justified level by about 12%. Although new
- ]6 v2 i; z8 ^units were being absorbed, homebuyers simply bought too
# U1 v8 s$ C2 f6 i) A5 [  \many houses at prices that exceeded fundamentals.
4 u/ P! h( R- {) ]3 m  VRegionally, we see the greatest strains on the Prairies,
# l' B3 p; C1 Q5 P5 c, F4 vwhere housing demand will further contract under waning
1 K8 o4 v/ V' Q9 t# L# h8 `' F( [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
* a1 a) o# V: ~7 c2 `0 `9 |0 ^buyers’ territory. Homebuilding in the Atlantic provinces
# `8 c8 B# L3 p# S& K3 Q: @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
( e6 G0 l* ^7 V5 ~: Jstrange accumulation of unabsorbed multiples on l’Île de
# h3 x2 |$ |9 u' D" Y7 u+ u0 j$ i+ XMontréal – but recent building has been relatively balanced,
, u$ f! C& [$ H# w6 c/ a, fgiven the province’s history of under-building and low ownership
- D; G4 K9 _8 l1 nrates. 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
high levels of apartment-style units presently under
construction mean that record numbers of condos will
4 Z# T/ T1 |7 A& t, l. K+ H9 [reach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
residential construction in B.C. will definitely droop, we
' q! J+ r; K6 }/ s/ Canticipate that the West Coast will continue to benefit from
& D6 N* d8 Q8 [% ^inter-provincial and international migration over the coming
years, which, along with improvements in affordability,
1 I7 K4 r0 B" n. Uwill alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
* d, F, W* I& e+ B: ~! mMARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
. c& I& @2 h3 S2 G% t  D. Y- M416-982-8063
Pascal Gauthier, Economist
( f' m* S& i2 ?+ s, g/ t5 k. X416-944-5730

http://www.td.com/economics/special/gb0409_housing_exec.pdf

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