TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
) I: O1 Y2 q& y1 d- ifrom 2002 to 2008, unsustainable price increases drove
- `: x/ O# P* j/ H; Dunsustainable levels of building. Our view is that house
7 P% S) \( S0 I3 Q( `6 F  cprices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
6 o& o3 h9 |/ E4 U1 i0 Joverpricing compelled a level of residential construction
+ [- D" h% P2 gthat exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
3 W/ }+ W+ W" Q: g+ n4 m9 uthree years.
- P5 e* I# A* n/ a5 kBy “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
" }+ h. C6 {& s! H. @both a cyclical downturn and a return of house prices
/ }  e$ E: R7 B3 z9 Y9 [  O! fto fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
3 Z( z# c: t" j2 v3 G" l9 Fwhere homebuyers buy up too many houses and
" b: S0 |( t) f& {* p  N2 A: uthat this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
' Z$ }1 a# n3 p" q' e4 athere is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
( Y6 ]/ x* U- Xhomebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
  L( m  e7 X  J( X6 C7 K: PWhile most markets won’t face U.S.-style overhangs,
the construction of too many new homes over the boom
) b* W4 e* d7 X! O1 c9 M8 ^means a deepened slump. This overbuilding will likely weigh
4 \( @$ h( S3 J$ n7 L  `on markets over the next few years. Even as Canada recovers
! `8 a; T8 r; |  j  Kfrom the cyclical downturn, house price growth will
remain choppy and new residential construction will be
$ G& G6 e. j, P( k/ jdampened, owing to this structural weakness. Construction
( Z, a9 R/ P- j0 A; ais now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
. j0 ?* z! Z  o: K# n+ E% G  V; E( @residential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
; O. X$ P. G3 |' xin the fourth quarter.
To quantify the degree of overpricing and overbuilding,
we first develop an empirical model, based on long-run
2 v7 @* F5 v' k; P, q1 X4 z# Pfundamentals of house prices and housing starts in each
province. Affordability is the key concept behind home
( Z' q. f- k6 d$ e4 Uvalues since house prices should track incomes over the
long-run. Since homebuilders build to meet demand, we
& |, T/ P$ |9 Q$ Lregard housing prices and household formation as the drivers
( |  ~$ x, f* P1 Kof residential construction.
. Y; N$ S5 \) t4 B; e: g4 HTo examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
) @, Z/ r" Q% n, b! ^! A& b/ nwould have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
7 E$ c( w7 Z# h/ E6 _0 W  tunits were being absorbed, homebuyers simply bought too
* {" O4 N8 q5 M; |/ W" m) ^$ C- {many 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
already witnessing surges in their unsold new homes at the
. T7 b! s; H! P' H- j! q3 every 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
0 o# v) P" k, P, Jweakness, will be singed by the downturn nonetheless.
% h) H4 V1 G5 ~" q5 n1 XQuébec shows signs of strain – especially given the
strange accumulation of unabsorbed multiples on l’Île de
Montréal – but recent building has been relatively balanced,
' l9 t! V4 L1 X' jgiven 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
condo market. Both in Toronto and Vancouver, historically
% j! ]( N5 R! L6 d" L1 ~high levels of apartment-style units presently under
construction mean that record numbers of condos will
& A% ?; `$ _; L% }# V1 [6 dreach completion during 2009. If absorption rates fall, as
3 I$ q* }+ ?/ u4 Q" G" mcyclical factors would indicate, condo inventories could
/ ^# @6 j) U' N- g' B7 M% C/ _2 _spike severely – particularly in Vancouver. However, while
residential construction in B.C. will definitely droop, we
0 \- `2 c( X; h$ ]) `5 r, panticipate that the West Coast will continue to benefit from
inter-provincial and international migration over the coming
years, which, along with improvements in affordability,
6 ]% Y: ^4 j4 _1 p% uwill alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
0 d0 E6 @& |, R+ `% U; b5 bGrant Bishop, Economist
- v( i! b+ e' C6 z/ L' C416-982-8063
Pascal Gauthier, Economist
9 j6 ^& N/ p& a5 h4 i416-944-5730
% ]8 R( w0 g% b) ^/ ?0 [
& I# ^5 D; @- shttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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