TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
  x- m& [: r# B+ zfrom 2002 to 2008, unsustainable price increases drove
- u- v4 Z1 L6 f+ d) E& Wunsustainable levels of building. Our view is that house
  U* @4 N" d7 F! Jprices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
5 V( t: [* V' goverpricing compelled a level of residential construction
( ]2 W) z8 b8 ~4 M# Zthat exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
three years.
3 j. k5 {# x) ], h6 \8 fBy “overpricing” we mean that prices detached from
* g; a% G9 X3 U! b9 S1 j4 btheir fundamentals, as witnessed by a steep erosion of
5 F, l/ Z( k. a. iaffordability. The current unwinding of house prices reflects
0 [! T( N' J6 [7 W$ C9 Vboth a cyclical downturn and a return of house prices
& f' |+ J6 A2 ^; @to fundamentally justified levels.
- S9 r% o# I! u7 p; bWe 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
7 g. q3 D9 Q0 }: D/ p5 B+ h& b“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
9 D2 i2 G5 O% s  Othat is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
" i% \  e0 X3 R8 Y; s9 }the construction of too many new homes over the boom
6 _$ N- T4 B% C  P2 A/ xmeans a deepened slump. This overbuilding will likely weigh
4 c/ i1 j; z- d- K! f0 Y# gon 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
5 Q( _5 a  D8 `! ]1 Hdampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
residential construction will fall further to around
- |3 z3 z) t. g7 n1 n, K125,000 starts over 2009 with a trough around 115,000 units
' h1 \8 [0 X$ t: }" s7 \- c/ xin the fourth quarter.
, y, W0 w  U0 I! b, {: q3 c1 NTo quantify the degree of overpricing and overbuilding,
we first develop an empirical model, based on long-run
/ `1 y8 w# N5 |* u( zfundamentals of house prices and housing starts in each
province. Affordability is the key concept behind home
% ^6 |9 I- P9 yvalues 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
) f. f. [1 J) Hof residential construction.
To examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
; [; p. T# k. w2 O+ d. Lwould have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
# ?/ L4 m( i$ [( Q' B- Pfundamental-justified level by about 12%. Although new
. l" ^4 l" p; q2 v" l" vunits were being absorbed, homebuyers simply bought too
1 i2 v0 S# G( e5 V7 @/ N3 q  Dmany houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
3 e$ s! R1 O8 ^  t$ ywhere housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
* b- A& o; w1 _0 tvery 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.
Québec shows signs of strain – especially given the
6 \! K3 h+ j' I% E4 Hstrange accumulation of unabsorbed multiples on l’Île de
% ?; t; t2 u, V4 zMontréal – but recent building has been relatively balanced,
given the province’s history of under-building and low ownership
0 g  D/ J  ?; h$ Urates. While Ontario homebuilding will reel from a
/ r" m1 C8 M4 D8 w0 Ucyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
  E# T4 _4 B1 u" g1 |. X2 A! Z2 dcondo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
2 [9 w' i8 q# T/ Hconstruction mean that record numbers of condos will
- u$ j: X* o: D/ Q) L. Lreach completion during 2009. If absorption rates fall, as
7 ]9 }& R! w+ l( `  zcyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
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,
$ R* |% K# Y6 a+ i% S+ cwill alleviate some of the pressure from overbuilding.
1 t* L) l$ i9 I+ I# o. L" a- jOVERPRICED AND OVERBUILT: CANADIAN HOUSING
3 W+ X! b5 s5 G) n% XMARKET RETURNS TO FUNDAMENTALS
9 V6 r4 c" Z2 G  x3 IGrant Bishop, Economist
: h" R2 C3 ~0 b! a8 b416-982-8063
% V& d9 h+ ?' B5 d( |3 F& oPascal Gauthier, Economist
9 |% a3 `' f) z# k1 b416-944-5730
+ p( o& b9 Y  i; X
http://www.td.com/economics/special/gb0409_housing_exec.pdf

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