TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
  z/ M7 M3 F9 t0 c& ]from 2002 to 2008, unsustainable price increases drove
. j) ?  B- F0 B* r* w) |unsustainable levels of building. Our view is that house
! F2 e% ~- ], ^3 U0 n8 R4 P% y( Yprices exceeded the value of housing that was justified by
8 l" G( v* k  F6 Kfundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
9 g& U' S2 _7 d3 j) Q: n+ P12%, an excess that was exaggerated in the past
& ~1 o1 {( i+ ~" z  ^three years.
By “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
& T6 ]) V' p% N2 a/ Q) xaffordability. The current unwinding of house prices reflects
both a cyclical downturn and a return of house prices
" z# s# V$ ~; E. b6 p: Nto fundamentally justified levels.
% R- s) w- y9 o  E$ c9 e- dWe consider “overbuilding” of two forms: “demanddriven”
, R/ U( D9 I1 r; Pwhere homebuyers buy up too many houses and
+ O5 v: J1 i7 j! v$ J% D$ l3 Vthat this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
* A) V7 R' h; o/ h$ B# {there is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
% L- v8 P6 B' [( }' wthat is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
% G& _, R/ B; P+ D6 o9 P* j# R: Xthe construction of too many new homes over the boom
0 B5 a4 g0 L. ameans a deepened slump. This overbuilding will likely weigh
* z9 K1 C0 v3 e6 z4 son markets over the next few years. Even as Canada recovers
from the cyclical downturn, house price growth will
  }  Q. }/ M  h. S1 P" gremain choppy and new residential construction will be
: i) B; c: a( J4 E* x9 Fdampened, owing to this structural weakness. Construction
! a- @  m7 _% l' ris now undershooting fundamentals and we expect this
1 H6 W3 l+ R! ?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
; w) g1 k3 B" W. W" Kin the fourth quarter.
To quantify the degree of overpricing and overbuilding,
4 p# i( c% m! a  K  p$ U/ Fwe first develop an empirical model, based on long-run
fundamentals of house prices and housing starts in each
% A1 A# f4 d3 N1 l) gprovince. Affordability is the key concept behind home
$ w2 H: H5 j  g" S: w8 B( S) N0 \values since house prices should track incomes over the
long-run. Since homebuilders build to meet demand, we
: s4 M7 K! ]3 M4 j. Nregard housing prices and household formation as the drivers
* q' R6 @# A/ D7 oof residential construction.
To examine the degree of overbuilding, we employ a
7 m% {- }/ V0 g0 n2 l+ N“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
6 C& a2 S# W1 f; t9 t+ J- hoptimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
& f0 O; c, L9 _) |& w8 }4 imany houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
( P# `3 Q4 Q7 S3 q1 vwhere housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
# x* }9 K) G! B& y. {already witnessing surges in their unsold new homes at the
very time that the resale market has swung into strong
/ `" E- n% r) jbuyers’ territory. Homebuilding in the Atlantic provinces
$ Y! _' y* b3 b" E' f1 v) p4 zhas been relatively balanced but, while not plagued by structural
7 K! |0 V! C0 z0 h8 ]( `, V' _weakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
strange 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
rates. While Ontario homebuilding will reel from a
/ p8 t* ?* U, v! o% p: h- \- Mcyclical downturn, the degree of structural weakness appears
- H; n: U. }& u* ^0 `( mlimited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
- \: J' X# J" e" W. }construction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
  v7 t. L/ {, u% b+ l1 @cyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
# i9 |) o6 p7 n' f6 Kresidential construction in B.C. will definitely droop, we
anticipate that the West Coast will continue to benefit from
6 `0 [6 _) v! l+ F. w( ~inter-provincial and international migration over the coming
5 s; D3 C# |) J; U" M; ]years, which, along with improvements in affordability,
' }9 H7 J" @7 d8 N2 ]0 h; L, Twill alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
% D! C% r) k) b. H) x5 OGrant Bishop, Economist
416-982-8063
Pascal Gauthier, Economist
416-944-5730
: w0 u. ~6 e$ W  c! k; P8 ?
0 X( ?  w" A: t# n! ~http://www.td.com/economics/special/gb0409_housing_exec.pdf

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