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
( k0 }8 m3 d' K- @  _unsustainable levels of building. Our view is that house
prices exceeded the value of housing that was justified by
+ B' q" J; j6 z: [4 kfundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
- i' ]; c; U4 O, }& {. w12%, an excess that was exaggerated in the past
three years.
By “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
1 P  h: B% x2 A, l. W( t3 u) baffordability. The current unwinding of house prices reflects
- y" r6 ~$ y0 xboth a cyclical downturn and a return of house prices
5 w+ @2 @2 t& i) a( lto fundamentally justified levels.
/ V# w6 V6 R/ D5 [We consider “overbuilding” of two forms: “demanddriven”
1 R3 e6 j3 U9 ]where homebuyers buy up too many houses and
/ X  G2 I" c; gthat this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
. V2 v- ~6 a- u2 |. B* Gthere is evidence of both types, we contend that Canada’s
5 P7 P/ v$ b9 H6 Y“overbuilding” was mainly of the first type, where
3 H2 E( q8 f( n1 A4 X+ ghomebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
4 m: m6 M& H. a% ?* C# H" fthe construction of too many new homes over the boom
/ c) A) ]5 x$ N6 I7 s" Xmeans a deepened slump. This overbuilding will likely weigh
on markets over the next few years. Even as Canada recovers
- C! @: p) a- E6 [from the cyclical downturn, house price growth will
5 p7 g4 W7 {3 ?. p) \9 W9 bremain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
& B/ ]% A0 q) Xis now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
  l. s5 o$ L0 `# v, cresidential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
To quantify the degree of overpricing and overbuilding,
  ^6 c% ^* ^# d/ `# f8 L* Bwe first develop an empirical model, based on long-run
! y% o2 k9 T0 N6 N( r3 j1 yfundamentals of house prices and housing starts in each
9 C' c7 D+ z" M* R" N0 pprovince. 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
% h7 H6 z6 R6 K/ [7 L5 H8 x0 |: |regard housing prices and household formation as the drivers
7 i  ]( @  S  w& i3 t8 Gof residential construction.
8 _* A6 c( f4 G  z, A! e1 C# v) LTo examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
+ O; G4 {& N2 f; e, a4 O* Zfundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
- b: R: V/ F/ t9 l2 ]* ERegionally, we see the greatest strains on the Prairies,
2 X4 w. A- t4 `5 u0 u9 l" V% bwhere housing demand will further contract under waning
2 a  ^  s- @" Q7 A3 xpopulation inflows. Saskatoon, Calgary and Edmonton are
5 P0 n/ e2 \2 M' O; Y1 Walready 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
( j& ?# _& i; M, h) @has been relatively balanced but, while not plagued by structural
; P% e' x9 \. n- d7 d6 zweakness, will be singed by the downturn nonetheless.
8 c4 a$ l7 p# T* e9 U' t" KQuébec shows signs of strain – especially given the
9 `% W0 d+ |) H" s& vstrange accumulation of unabsorbed multiples on l’Île de
Montréal – but recent building has been relatively balanced,
  t2 a9 Q+ u3 z9 r6 Dgiven 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
4 R+ B! e2 N2 _+ elimited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
/ E4 C# o# c  d& M+ |construction mean that record numbers of condos will
3 q( R% m+ M  x( N, ^: Mreach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
0 e# v$ \; |' F! a9 n/ p; U% Jspike severely – particularly in Vancouver. However, while
residential construction in B.C. will definitely droop, we
9 ^1 k. g( S. A9 m% Z  O2 A# Q7 w$ santicipate that the West Coast will continue to benefit from
8 w5 ~6 y% m9 O' `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
1 ^% h3 k$ J& {7 Z- P% w5 |Grant Bishop, Economist
- o. _- `1 O: f2 t4 Z) l4 |) N+ u) A416-982-8063
& Q; E6 ?4 a/ h4 W+ @0 qPascal Gauthier, Economist
416-944-5730
3 n" x) R. l4 l7 w- h
% d2 `8 V) h- e* N+ W- l9 U3 ?http://www.td.com/economics/special/gb0409_housing_exec.pdf

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