TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
, H! X0 J, ?; D. B0 C" pfrom 2002 to 2008, unsustainable price increases drove
9 Y4 _2 z" B6 M2 u* Bunsustainable levels of building. Our view is that house
. q# J1 G% E2 b( h. n% R! E# b2 Y+ fprices exceeded the value of housing that was justified by
* V. ]: B' m* n) D% s) u3 ]6 V: `fundamentals by approximately 9% nationwide. This
. ^+ M3 t$ |( _, n* loverpricing compelled a level of residential construction
7 G$ C( v4 [, D1 n" jthat exceeded its fundamental-justified level by approximately
" ?* y2 [' i9 ~4 o* g) y" F& W0 ~12%, an excess that was exaggerated in the past
three years.
By “overpricing” we mean that prices detached from
4 P2 @  a+ d- P7 K2 u! @their 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.
We consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
6 T* p: q) B  Y/ g! g* @& t" swhere builders accumulate excessive inventories. Although
# N# j# K5 A( d9 V* b. kthere 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
that is now being rapidly reined in.
# }/ R9 p5 O# H/ NWhile 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
on 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
dampened, owing to this structural weakness. Construction
( f7 T. |# q* s! _' v4 ?( Ris now undershooting fundamentals and we expect this
, S4 d/ o. _  V: }4 Rto persist over 2009 to 2011. We anticipate that nationwide
# S5 p% T* k3 q) T5 [residential construction will fall further to around
! O% X: w; u: H' [! v7 j& `125,000 starts over 2009 with a trough around 115,000 units
/ ]! [# J' K+ y0 uin the fourth quarter.
. d/ X/ ]0 F8 p# T2 ~To quantify the degree of overpricing and overbuilding,
we first develop an empirical model, based on long-run
* V  H" \, a8 W) [  w- a: pfundamentals 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
& S0 s: Q* ~% z0 m# a6 {& zlong-run. Since homebuilders build to meet demand, we
regard 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
1 u' E3 O( Z6 ~" i( @4 zfundamental-justified level by about 12%. Although new
+ C) c+ b4 b; A1 D4 A) W" Iunits were being absorbed, homebuyers simply bought too
9 N0 ]  W+ _, E2 K# mmany 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
( J# e8 X; J, K, o& malready witnessing surges in their unsold new homes at the
very time that the resale market has swung into strong
5 s; t0 h* s* z! v+ jbuyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
& a. U5 c0 r9 c2 x& D+ d& lweakness, will be singed by the downturn nonetheless.
) L4 }+ ^& d$ g% WQuébec shows signs of strain – especially given the
strange accumulation of unabsorbed multiples on l’Île de
Montréal – 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
9 S  _$ E/ Z3 C" z+ i5 i+ Plimited – with the important exception of the Toronto
/ L8 T8 a! F8 Gcondo market. Both in Toronto and Vancouver, historically
8 l4 E& z( f) g( Qhigh levels of apartment-style units presently under
2 k$ |/ `: k2 l3 Mconstruction mean that record numbers of condos will
& G: ~3 v# ^% x% G% e$ V7 oreach completion during 2009. If absorption rates fall, as
5 r' l; ^9 a+ Z- C" ocyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
8 S! m) N8 T; V5 H; c' F9 Yresidential construction in B.C. will definitely droop, we
/ h0 u  U/ V! g4 _anticipate that the West Coast will continue to benefit from
0 R5 o( u  l) \. Pinter-provincial and international migration over the coming
9 T4 l# W$ X% ~# myears, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
5 b+ S5 n6 w4 [, S) a$ z9 pOVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
) F. O* p- }" }& sGrant Bishop, Economist
416-982-8063
Pascal Gauthier, Economist
% E. T+ j+ i4 i+ a7 d) D1 c5 J* e416-944-5730

7 W6 O  @1 U% a1 h. Thttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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