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
unsustainable levels of building. Our view is that house
6 {7 n+ a. P! i0 rprices exceeded the value of housing that was justified by
2 y+ v1 h! e% k; q: X+ Ofundamentals by approximately 9% nationwide. This
  Q" V9 G  a* W* Z/ d9 F/ r) \& l* D, `' i  Xoverpricing compelled a level of residential construction
& F1 n: W+ l' v( F5 g/ L7 T: g$ O2 \that exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
+ `2 L' ?! S& D: Pthree years.
By “overpricing” we mean that prices detached from
their 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”
) m+ ?& g" H1 E5 b' A, D, hwhere 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
4 p. g0 K7 {0 {“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,
the construction of too many new homes over the boom
means a deepened slump. This overbuilding will likely weigh
+ F4 _, L" a& y7 ^' A: aon markets over the next few years. Even as Canada recovers
# P2 A/ A4 z9 j0 R7 P2 Ufrom the cyclical downturn, house price growth will
remain choppy and new residential construction will be
, v% l: O; M, ?: K3 \! ~4 Wdampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
/ X# }3 R- E  G' _+ mto persist over 2009 to 2011. We anticipate that nationwide
: E$ V7 y- [" L( Zresidential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
: r" b) O; Y8 l9 xin 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
province. Affordability is the key concept behind home
( Z& l- B: v7 }values since house prices should track incomes over the
long-run. Since homebuilders build to meet demand, we
# T* j' V. q' J6 Xregard housing prices and household formation as the drivers
5 }& m" `9 a9 K% e- xof residential construction.
9 G+ A6 T. C; _- ]8 A* W; gTo examine the degree of overbuilding, we employ a
8 Y/ t2 h/ C0 }# X, s7 k* L' e“counter-factual,” asking what level of residential construction
6 _2 V. ^. H& I% f8 l' nwould have occurred if housing had been priced
, z! ^* q0 \  c+ ^optimally. We find that actual homebuilding exceeded this
4 ^# }" f+ R4 L# j6 Pfundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
( f' F! Z/ K0 x/ g1 x2 X' emany houses at prices that exceeded fundamentals.
8 g' R$ Y# N2 t! B: FRegionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
4 I- N! X/ p1 x; ~population inflows. Saskatoon, Calgary and Edmonton are
! t, p4 E- y2 W5 Yalready 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
2 t" t7 G1 S+ ^( g2 T& Nhas been relatively balanced but, while not plagued by structural
( B, ]' ^4 P" s. V, P; kweakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
0 t1 [9 z6 Q* Cstrange 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
) f2 W1 }! O# Z  w! c/ lcondo market. Both in Toronto and Vancouver, historically
* \- Y  L" Z) t" Ehigh levels of apartment-style units presently under
' {* P' B5 V0 h6 S- U# Aconstruction mean that record numbers of condos will
- S) q6 `: R, vreach completion during 2009. If absorption rates fall, as
$ }$ z9 f3 @7 \5 Z- fcyclical factors would indicate, condo inventories could
4 z# o, R! P! v. r2 Dspike severely – particularly in Vancouver. However, while
' ^# t/ e% _9 r3 F4 O3 E6 iresidential construction in B.C. will definitely droop, we
; U; {/ i. w" U) ganticipate that the West Coast will continue to benefit from
inter-provincial and international migration over the coming
years, which, along with improvements in affordability,
& \* s/ Z, P" N5 g! Mwill alleviate some of the pressure from overbuilding.
% m) n8 u* \4 @& c/ M( R- XOVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
Pascal Gauthier, Economist
416-944-5730
' s8 G3 T  A% }1 u' O
http://www.td.com/economics/special/gb0409_housing_exec.pdf

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