TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
- }: O* x0 f' \2 v7 Z$ G# qfrom 2002 to 2008, unsustainable price increases drove
9 A, u' \. E. T2 E  nunsustainable levels of building. Our view is that house
4 n  R  E  C" hprices exceeded the value of housing that was justified by
$ D+ @% I9 y" h" D+ u6 Ffundamentals by approximately 9% nationwide. This
8 u2 x! ^3 P* B1 boverpricing compelled a level of residential construction
+ w$ Z' `. U6 G7 F7 C8 p: b/ Othat exceeded its fundamental-justified level by approximately
. d6 n8 p" D; v/ Z12%, an excess that was exaggerated in the past
$ c$ f# l1 d+ ?* vthree years.
3 y" h$ j3 {5 o$ V* d; sBy “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
! m: a3 _& m3 n0 {affordability. The current unwinding of house prices reflects
3 A" l  L: H$ E0 N8 Hboth a cyclical downturn and a return of house prices
$ C5 r! a; b" _1 L  S7 u" Q, Oto fundamentally justified levels.
* N. `; p. \9 |. [2 qWe consider “overbuilding” of two forms: “demanddriven”
- B: H: u" Q8 a" w) E! E* Ywhere homebuyers buy up too many houses and
6 C# Y; i# S% N, V/ a$ p* A" Cthat this demand cannot be sustained; and “supply-driven”
# G+ I% k" c% P; L! twhere builders accumulate excessive inventories. Although
) Q8 D% r5 U9 Zthere is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
5 T; U/ o' ^' t  c# f" ^4 s% J0 Vhomebuyers pushed homebuilding to an unsustainable pitch
) H) ^: z" {- a/ G' xthat is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
/ o! O3 ~( ~0 {) v) L/ Z3 rthe construction of too many new homes over the boom
! {8 ?& r3 [2 ^means a deepened slump. This overbuilding will likely weigh
on markets over the next few years. Even as Canada recovers
) X9 ?7 K$ O  B! m2 m: ifrom the cyclical downturn, house price growth will
/ O6 m% m9 [: p& \/ q2 dremain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
3 D1 y( F2 y* f5 Yresidential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
* _( x% k$ O1 q; V( e0 k1 Pin the fourth quarter.
To 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
0 i  G' z& \* {, b4 r! Zprovince. Affordability is the key concept behind home
- i7 U- i2 S; S& _4 Mvalues 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
* y) b, x; u% s* Wof residential construction.
+ V: X; k9 |6 E5 M) ?0 cTo examine the degree of overbuilding, we employ a
+ o% K, ?+ ]# E) y* t6 |“counter-factual,” asking what level of residential construction
' w( I2 W& l# N1 J4 twould have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
9 k) `7 [! }/ u. T* cmany houses at prices that exceeded fundamentals.
9 {# h  Z8 U) ^2 ~! L/ Y4 m! |1 X& zRegionally, 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
* y( w) B' l9 I9 @5 v* r1 O8 uvery time that the resale market has swung into strong
8 u7 ^( M6 O. Xbuyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
9 b2 X* S* N, n4 hweakness, will be singed by the downturn nonetheless.
4 e# B/ i. c( m. d% G9 R2 TQuébec 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
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
2 v; B$ W6 U: i- Z# f- t' nreach completion during 2009. If absorption rates fall, as
& F' W( ~8 G/ A9 V/ N9 e3 Q* {7 zcyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
' H& I- \1 d) |residential 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
years, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
! H2 g2 Q8 a# Y7 Z( _8 {: e5 YPascal Gauthier, Economist
9 f+ J* I8 T6 z  T; |3 x416-944-5730
1 d: U; y  ~+ f% E/ e* t9 t
http://www.td.com/economics/special/gb0409_housing_exec.pdf

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