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
prices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
/ I7 E/ Z$ V  m. r3 Gthat exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
8 L7 N" S4 \% X. athree years.
9 U5 ^- H0 J1 N$ w; C) w, `; DBy “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
, q' ^$ g/ T- Q4 i  j" xboth a cyclical downturn and a return of house prices
to fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
/ v- E1 p6 Y+ B9 q7 q) a  C: @2 jwhere 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
0 Z0 u4 l: b8 N  L“overbuilding” was mainly of the first type, where
" [& z1 H6 T7 Whomebuyers pushed homebuilding to an unsustainable pitch
5 N) B% ?- e( P6 h# P! \% A" tthat is now being rapidly reined in.
" B# O1 \4 |" a4 g7 ]  h0 e5 n! {/ @" ZWhile most markets won’t face U.S.-style overhangs,
' \2 _6 s% y: b) w3 Z; dthe construction of too many new homes over the boom
3 M+ `+ m  U- h% s# lmeans a deepened slump. This overbuilding will likely weigh
6 M% d, J1 J8 b; A, Zon 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
- w% o% }+ G3 t1 @5 [& Q0 N9 ?6 ]dampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
1 X* A1 x( d/ |: K: yto persist over 2009 to 2011. We anticipate that nationwide
residential construction will fall further to around
2 p) \) b! M8 a5 T125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
To quantify the degree of overpricing and overbuilding,
we first develop an empirical model, based on long-run
) K9 B( }5 ~' K9 ufundamentals of house prices and housing starts in each
province. Affordability is the key concept behind home
values since house prices should track incomes over the
9 ]! f! r. L" R1 Jlong-run. Since homebuilders build to meet demand, we
" j- X+ a4 Z3 |! f  }regard housing prices and household formation as the drivers
of residential construction.
5 F/ T& m) Q5 ^5 T. @# [9 [To examine the degree of overbuilding, we employ a
" B5 A" y! x" r! b( }5 W; `% Z“counter-factual,” asking what level of residential construction
7 Q3 c8 z4 j& U  _" q6 @2 Uwould have occurred if housing had been priced
7 C8 u4 g0 V. W( s' c1 [/ P# Moptimally. We find that actual homebuilding exceeded this
; h  {/ E4 o0 y' j% @- gfundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
8 d& N: i, t8 `Regionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
& V( b( V1 A! o" N+ Spopulation inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
: @- z1 B& R+ T" V% [very 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.
* K7 D4 T* g6 C1 S& GQuébec shows signs of strain – especially given the
' ]8 P3 U9 w" \5 Lstrange accumulation of unabsorbed multiples on l’Île de
Montréal – but recent building has been relatively balanced,
- t5 Y2 H6 X, z4 egiven the province’s history of under-building and low ownership
; {4 l7 E7 p* x" k- a# `rates. While Ontario homebuilding will reel from a
9 x& ]* w" [/ scyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
. I# u( H8 i6 e; Ucondo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
5 v; k  w# U3 L0 N  J' r) pconstruction mean that record numbers of condos will
; W! ^  i) b7 M" [. s7 v; ireach completion during 2009. If absorption rates fall, as
cyclical 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
: O: l0 U! H: A4 q& n* wyears, which, along with improvements in affordability,
% O0 p1 P/ ^0 N! Gwill alleviate some of the pressure from overbuilding.
" x% b3 X5 N8 K0 u- H9 WOVERPRICED AND OVERBUILT: CANADIAN HOUSING
, @$ v* F& }9 ^) SMARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
Pascal Gauthier, Economist
416-944-5730
7 R# N- _0 w, E9 b
& i+ X) M% n; [7 L$ Lhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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