TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
7 B$ l" ?7 V, y5 `& K4 }! bfrom 2002 to 2008, unsustainable price increases drove
; o1 P. O& D2 F2 S9 Nunsustainable levels of building. Our view is that house
. @, S! u5 _: r8 c, [# Oprices exceeded the value of housing that was justified by
) o: ^3 f+ q& q# o1 x6 Cfundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
% @9 N+ g8 \! z. Q. o6 A' vthat exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
three years.
; N: V8 h6 i7 D! |4 L! BBy “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
. Y2 G  `8 g7 g% n8 ~7 daffordability. The current unwinding of house prices reflects
both a cyclical downturn and a return of house prices
5 U# ^3 ?* U. P6 y0 qto fundamentally justified levels.
We 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
- C( G( |2 n" M7 N, g7 q5 \there is evidence of both types, we contend that Canada’s
  P8 Q  b0 ?; v- _5 }+ N  i" _“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
1 o$ r3 z/ I* }that is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
- Q/ d9 D0 N$ b: t! B' uthe construction of too many new homes over the boom
- t8 m7 o7 s; @means a deepened slump. This overbuilding will likely weigh
. _! }$ n& O$ V% g5 E+ Don markets over the next few years. Even as Canada recovers
, ?" X( E# _" H! A. A/ p0 `from the cyclical downturn, house price growth will
4 {/ J' A1 B6 i$ wremain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
5 ]3 C  R; H0 ]2 p6 ?, jto persist over 2009 to 2011. We anticipate that nationwide
residential construction will fall further to around
. G% j7 U9 F" j% a* n125,000 starts over 2009 with a trough around 115,000 units
8 k+ [+ g0 |/ L& R$ V: L' min the fourth quarter.
9 ^8 a# c% C0 JTo quantify the degree of overpricing and overbuilding,
* ]7 `' B2 O7 p' ?/ Mwe first develop an empirical model, based on long-run
fundamentals of house prices and housing starts in each
1 W' U) C& Q) {$ E/ P& A& _province. Affordability is the key concept behind home
; x$ c; a% m' B$ G2 A; `values since house prices should track incomes over the
( @. s. K7 K7 G7 Elong-run. Since homebuilders build to meet demand, we
regard housing prices and household formation as the drivers
of residential construction.
' g) Q. V, d: [# K' j0 KTo examine the degree of overbuilding, we employ a
7 i: Y( Y: b$ F' Z3 z/ K“counter-factual,” asking what level of residential construction
would 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
) U& o5 G+ ~! P! Emany houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
  I' Q9 u2 l4 U2 C; ialready witnessing surges in their unsold new homes at the
, P' C3 i9 E% b% Q3 o! Q% G$ y" ~2 V0 uvery time that the resale market has swung into strong
, b& Q6 V4 `* Ebuyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
weakness, will be singed by the downturn nonetheless.
+ w# }) S! b  [Québec shows signs of strain – especially given the
  r/ G, u1 G" S' J+ Tstrange 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
  E6 t; H3 X2 K. nrates. 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
9 A. j5 @/ p# n7 ~9 O! u& uhigh levels of apartment-style units presently under
0 P% E# H; b/ Cconstruction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
7 Q; |; n8 U. U+ q  \. _0 wcyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
residential construction in B.C. will definitely droop, we
% F! X& ~! \! k/ w6 T# Eanticipate that the West Coast will continue to benefit from
inter-provincial and international migration over the coming
years, which, along with improvements in affordability,
8 V+ c& m" I& Z8 }# m% X4 ^; Ewill alleviate some of the pressure from overbuilding.
1 f9 n  f) L0 y! M% x3 u$ _" _OVERPRICED AND OVERBUILT: CANADIAN HOUSING
$ _  g5 ?+ o& P9 yMARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
) F* T; ]9 X0 T' }9 L: Y$ RPascal Gauthier, Economist
416-944-5730

http://www.td.com/economics/special/gb0409_housing_exec.pdf

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