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
; A1 q  _5 H: D3 yprices exceeded the value of housing that was justified by
9 s$ A$ Z& O& {! Efundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
5 y# o7 F& }/ j) l  Z3 S9 P5 O12%, an excess that was exaggerated in the past
0 D' _" T7 v$ |$ m  r% K* B* s' wthree years.
. x% |1 {+ Q6 j4 q' q% u! K3 H0 e, WBy “overpricing” we mean that prices detached from
0 J- r) |: Z3 s5 _5 ^their fundamentals, as witnessed by a steep erosion of
7 ]( G# Y+ o. ?" K$ uaffordability. The current unwinding of house prices reflects
" }% w0 Y+ b+ ?/ f. W# p! p! ^both a cyclical downturn and a return of house prices
to fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
3 S$ y5 Z, \' C- R( _) {# N& dthat this demand cannot be sustained; and “supply-driven”
1 P% W9 V$ D$ j* r% ]where builders accumulate excessive inventories. Although
% ^- j; D+ i5 Nthere is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
7 O3 a2 m' j/ K4 H7 i% l8 sthat 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
, m/ L7 y& i2 E4 c1 Z4 bon markets over the next few years. Even as Canada recovers
- b, j4 E! W  g  Y) U# Mfrom the cyclical downturn, house price growth will
$ B! g# Q5 k, Q. G9 D$ n: \remain choppy and new residential construction will be
* \9 ?+ [8 P* L  f% _" c) sdampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
/ a& V  c0 n2 P& i* q' m) J# Sto persist over 2009 to 2011. We anticipate that nationwide
residential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
+ B& R) O- [8 ?# m4 hin the fourth quarter.
To quantify the degree of overpricing and overbuilding,
% X) n3 c7 H9 O2 T, Qwe first develop an empirical model, based on long-run
5 [2 q; M6 S4 s! f" |4 ~8 xfundamentals 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
! V- o% W7 {: ~. M, ^3 `long-run. Since homebuilders build to meet demand, we
/ V. A) ?, ^0 C$ |7 E! s2 `, Y/ lregard housing prices and household formation as the drivers
of 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
optimally. We find that actual homebuilding exceeded this
( o; Q4 D# u6 X  ?9 H7 }fundamental-justified level by about 12%. Although new
; g( e4 @. K0 k0 xunits were being absorbed, homebuyers simply bought too
6 s; ^- S. ?/ d8 J9 bmany 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
4 \, Y5 H" |8 C* s0 U! malready witnessing surges in their unsold new homes at the
+ X4 ~3 |$ s5 ^8 u" Svery time that the resale market has swung into strong
buyers’ territory. Homebuilding in the Atlantic provinces
) c0 B' Q- O0 p( q$ J5 ihas been relatively balanced but, while not plagued by structural
7 o0 K& h# a2 ?; kweakness, will be singed by the downturn nonetheless.
, D% \+ @3 n. L% k6 U' |: UQuébec shows signs of strain – especially given the
+ d, N) {% T& J( Z" tstrange accumulation of unabsorbed multiples on l’Île de
6 Y; r/ V3 M& gMontréal – 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
8 N! W  n& f8 _) B8 t' `condo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
construction mean that record numbers of condos will
  i; d2 D. p, D  D/ nreach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
1 r' ^$ t+ l. n" u+ ]! V" Jspike 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
- g4 A5 D" C+ W$ M, kinter-provincial and international migration over the coming
years, which, along with improvements in affordability,
' A1 n$ o/ |) G% P- O" Hwill alleviate some of the pressure from overbuilding.
, W; x6 [' M/ N( d4 b3 T1 |/ K$ NOVERPRICED AND OVERBUILT: CANADIAN HOUSING
0 J4 G" T. k3 l4 J/ q! y) dMARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
" ^2 @0 u' Y, H: Q8 Z416-982-8063
Pascal Gauthier, Economist
416-944-5730
) b! P" G' w* m( W/ S# x
http://www.td.com/economics/special/gb0409_housing_exec.pdf

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