TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
$ `# S2 {5 v( f4 [% T3 ~/ F0 |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
that exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
! s% c- A6 v! a2 \9 ?# X' k* Wthree years.
, g# ]; S5 r2 h. n  k% X8 HBy “overpricing” we mean that prices detached from
( s) b0 u3 K; B4 ~# e0 Atheir fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
% u# M3 [% P- G1 `& }both a cyclical downturn and a return of house prices
6 y- |: _& ?1 O$ @to fundamentally justified levels.
7 G& Y& s5 u4 o; H% J4 AWe consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
8 I- Q6 D- g0 i' q" _2 E6 @" athat this demand cannot be sustained; and “supply-driven”
) f0 J! \8 N  q: h& T8 \where builders accumulate excessive inventories. Although
- L9 X$ ?' \; N, n9 n5 y5 Qthere 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
* ?; ?; o$ `# v- }! ?' ythat 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
8 m# e" ]! L1 U1 w1 gmeans a deepened slump. This overbuilding will likely weigh
( X9 l+ ]* \; Q+ don markets over the next few years. Even as Canada recovers
from the cyclical downturn, house price growth will
# h: \- }; h- Y- aremain choppy and new residential construction will be
+ u  f/ s2 J$ ~dampened, owing to this structural weakness. Construction
% I; r4 C& i% \/ Q& E; X0 Yis now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
residential construction will fall further to around
3 }, _9 @; D+ ?125,000 starts over 2009 with a trough around 115,000 units
' v- {: E" E6 O4 z9 n# {in the fourth quarter.
To quantify the degree of overpricing and overbuilding,
we first develop an empirical model, based on long-run
$ I; J. H6 y) s: R& _6 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
long-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
, G* r! @8 N9 d$ b1 ?: Y1 Q/ Y2 H9 R“counter-factual,” asking what level of residential construction
7 K* r- R5 C! t7 Z& u2 dwould have occurred if housing had been priced
+ B3 [* D, x- h" z" zoptimally. We find that actual homebuilding exceeded this
7 f3 l& k  H8 E& h8 `fundamental-justified level by about 12%. Although new
# y: [$ k" Y' q) M) qunits were being absorbed, homebuyers simply bought too
, N" p( V* a4 A( Fmany houses at prices that exceeded fundamentals.
8 _4 ?! |2 I# E2 @+ d0 gRegionally, we see the greatest strains on the Prairies,
* Z* `: J9 r* K5 }* Uwhere housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
3 T5 U3 U$ J; P9 W  V  F# v+ U3 h# m% Nvery time that the resale market has swung into strong
- `( a$ D) W0 E" E9 ^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.
Québec shows signs of strain – especially given the
# U3 {- d: p: L' H  b  estrange accumulation of unabsorbed multiples on l’Île de
( i) b! _$ K! U' l0 ^2 u3 xMontréal – but recent building has been relatively balanced,
' _' c2 `( q% l+ Dgiven the province’s history of under-building and low ownership
, ?- [7 W1 P. l# L7 `2 drates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
2 F8 f) ?* X/ a' ?limited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
& l9 j5 g2 V2 ghigh levels of apartment-style units presently under
construction mean that record numbers of condos will
9 r& l2 d# ^0 J, oreach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
/ d+ l2 J  [( s) F/ ?, Q9 {( Fresidential construction in B.C. will definitely droop, we
  z  @  W) \. B' K; hanticipate that the West Coast will continue to benefit from
$ c- l2 L+ T5 ^) n7 }; O4 W7 e4 dinter-provincial and international migration over the coming
* V# t) X3 n9 Pyears, which, along with improvements in affordability,
) c9 U& P" g* S: _- K" iwill alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
  _9 |6 O) E/ }! DMARKET RETURNS TO FUNDAMENTALS
( k# a& F  c" g: s& i, Q7 AGrant Bishop, Economist
416-982-8063
Pascal Gauthier, Economist
2 g3 ]. ^! p' x* G9 W4 j# _1 K) T416-944-5730
" j4 B9 j% Y- ~) X" y
7 k) C0 V6 ~/ z, U6 F6 Dhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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