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
' P+ W# W% u3 G2 S( cunsustainable levels of building. Our view is that house
prices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
  o* V% o3 X( G% Y) Zthat exceeded its fundamental-justified level by approximately
7 A; S0 G8 T* |' r12%, an excess that was exaggerated in the past
% {- s+ e6 Y  x9 pthree years.
By “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
# l2 v6 Z( e' [, qaffordability. The current unwinding of house prices reflects
6 T9 j6 b! y" y' I1 Iboth a cyclical downturn and a return of house prices
5 F3 L4 u5 l% j& V0 [7 |to fundamentally justified levels.
1 n' i  w* }0 H5 w$ b( SWe consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
- P: f* c- o2 @1 r$ Mthat 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
, h1 F: S) g" N; |“overbuilding” was mainly of the first type, where
1 N$ D( t% g! U- e3 Uhomebuyers pushed homebuilding to an unsustainable pitch
- d: v# t: @0 K8 i3 {8 cthat is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
; Z4 d) u: @) q; x8 g/ }% }the construction of too many new homes over the boom
  y+ z2 Y/ \4 m, l7 Gmeans a deepened slump. This overbuilding will likely weigh
  m* I% s0 u, n8 |on markets over the next few years. Even as Canada recovers
from the cyclical downturn, house price growth will
remain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
0 u! t- q  l) s3 o& P, ~7 d  e7 pis now undershooting fundamentals and we expect this
& y, m8 ?( V' I+ L( H6 nto persist over 2009 to 2011. We anticipate that nationwide
+ Y" P" O) o( X; t& ]9 eresidential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
& p2 _, I$ R( M! s- Bin the fourth quarter.
0 r) c1 \8 W) X( c' h3 M6 YTo quantify the degree of overpricing and overbuilding,
  `8 C- m; H$ I) Nwe first develop an empirical model, based on long-run
fundamentals of house prices and housing starts in each
9 C, G1 G# [( G5 t5 X: j: jprovince. 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
/ \$ G& p! P5 [- l# m% r4 vregard housing prices and household formation as the drivers
of residential construction.
! `( r. I* ~* v- ], e+ J; ^* mTo examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
6 j! [/ K, ^; s. r9 Kwould have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
: f6 @, C6 n" Aunits were being absorbed, homebuyers simply bought too
3 a: J1 y! V% Z6 c6 Ymany houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
5 W3 O6 q0 r! H+ @5 v3 Dwhere housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
. p* M; U: j0 {already witnessing surges in their unsold new homes at the
very time that the resale market has swung into strong
buyers’ territory. Homebuilding in the Atlantic provinces
4 A& t0 Z. k, Phas been relatively balanced but, while not plagued by structural
weakness, will be singed by the downturn nonetheless.
" L* V8 Y9 r1 [, LQuébec 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
' x* z7 Z' b& Y: mrates. While Ontario homebuilding will reel from a
0 [7 V( V4 E# F: T/ b& \cyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
+ H- j! Y+ C4 {condo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
3 _6 P: x9 L# X+ U  a( econstruction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
2 y8 c5 r: x" _4 H, i0 s) h8 C: n% Mcyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
residential construction in B.C. will definitely droop, we
/ h$ x1 K, G4 W. \  m% @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.
7 R8 v8 ?+ q/ n1 K& @1 fOVERPRICED AND OVERBUILT: CANADIAN HOUSING
+ Q( g: R4 s- x' V, [5 Y3 PMARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
3 }% |* n1 Z+ \. I416-982-8063
Pascal Gauthier, Economist
416-944-5730
4 T+ u2 Z" f& C# {
0 ]# B# N5 i5 H* V  D2 ~http://www.td.com/economics/special/gb0409_housing_exec.pdf

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