TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
9 `+ t; f" J3 l: Ufrom 2002 to 2008, unsustainable price increases drove
unsustainable levels of building. Our view is that house
prices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
% `9 v  \. m( M' eoverpricing compelled a level of residential construction
" h( L& d4 e' V1 q7 v6 sthat exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
three years.
7 @! T% c2 J1 W& m* gBy “overpricing” we mean that prices detached from
% ]* s1 v; M( L* k9 j0 N& T' Itheir 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.
% t; Y) j: o0 ^& mWe consider “overbuilding” of two forms: “demanddriven”
' X+ b- q: F/ b3 V8 g1 t. k6 owhere homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
3 I* d+ S; I) Y: Bwhere builders accumulate excessive inventories. Although
: l% ^" }6 y) F5 ^8 u6 Kthere is evidence of both types, we contend that Canada’s
% u6 ^9 i8 O; Q# }: Z# Q' [& i2 V+ {“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
4 h% q3 Y7 A  g. fWhile most markets won’t face U.S.-style overhangs,
the construction of too many new homes over the boom
; u& C" V+ h/ e* z9 E9 W% Rmeans a deepened slump. This overbuilding will likely weigh
, L2 E% f1 b" bon markets over the next few years. Even as Canada recovers
- T  R3 B2 l+ i" y3 B  r& k/ rfrom the cyclical downturn, house price growth will
) x. A  }% Q3 |* p; s. Nremain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
* w8 ?* n; {4 t# ~is now undershooting fundamentals and we expect this
3 `2 K7 e0 o! a% V8 Gto persist over 2009 to 2011. We anticipate that nationwide
+ N  H+ [% I, t; G  r7 qresidential 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,
$ h* p% g  z2 V4 H$ uwe 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
3 l# ~8 C  V7 ~4 A7 Bvalues 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
4 e- p& ?+ ]8 f) C! J$ e. Iof residential construction.
To examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
& e2 w! b3 P1 c; s9 Y& Poptimally. We find that actual homebuilding exceeded this
- @- q6 H9 D9 p9 qfundamental-justified level by about 12%. Although new
9 m- X! J  P& Y8 x' i& k" runits were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
( x5 J0 l4 L3 x  G6 t/ k+ Kwhere housing demand will further contract under waning
( P2 h9 C8 m- G" C" Q2 Fpopulation inflows. Saskatoon, Calgary and Edmonton are
0 L+ u# g( e0 S. v1 f- L; u, U) Walready witnessing surges in their unsold new homes at the
- g6 X) K/ ?/ overy time that the resale market has swung into strong
) E1 {2 C( r; g6 A( J, u( 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.
Québec shows signs of strain – especially given the
strange accumulation of unabsorbed multiples on l’Île de
+ c$ P) G. M1 \" ^( x# A, G& B! sMontréal – but recent building has been relatively balanced,
/ _% u) E$ U; y. f( `given the province’s history of under-building and low ownership
/ ~6 e& X3 e7 n/ A# \7 Vrates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
& Y" |1 S- C" J: h: Plimited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
: B, @! d8 z8 f. e2 C( Uconstruction mean that record numbers of condos will
3 M$ P( P9 g2 h0 T$ i# \" l% wreach completion during 2009. If absorption rates fall, as
5 _5 q' A4 J' mcyclical 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
) x$ H4 J7 n# W- B  `* G  w$ ointer-provincial and international migration over the coming
years, which, along with improvements in affordability,
( @( m, m1 C7 `. M: Lwill alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
9 p. ?) B; s$ O( m+ jPascal Gauthier, Economist
+ o" q+ ?3 g0 f* V416-944-5730
1 s; p" C0 e! q  b& V$ {6 \
4 x6 U$ `& J( Ghttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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