TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
: C5 o! Y* J* j4 ^from 2002 to 2008, unsustainable price increases drove
7 ?, a( _5 [3 |4 }% N1 w# Aunsustainable levels of building. Our view is that house
  p. i" r& w; q& }* ]7 |$ {% C7 jprices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
0 W: m+ H9 D; v6 K. ^1 F. Qthat exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
1 C, M1 D& q% R+ l( P% ethree years.
By “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
: D) F  K% B% S( o9 N+ Cboth a cyclical downturn and a return of house prices
$ B5 Z& ?+ q- D0 X" Y( }to fundamentally justified levels.
" T8 m3 O: e' I0 S3 l0 q, g/ ~We consider “overbuilding” of two forms: “demanddriven”
. S' Z; p. h, N  E# Fwhere 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
“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
- Z! B2 m" j3 ^8 i' c( W7 c9 dWhile most markets won’t face U.S.-style overhangs,
! x, {- v. U1 y# l) M9 v6 g: f. Gthe construction of too many new homes over the boom
* `# l; {9 F; X0 mmeans 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
' M  S' p4 g" w9 I+ Fremain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
7 @# x. c' ~& t* t8 m  Qis now undershooting fundamentals and we expect this
+ K* k1 ?" q( _2 i6 \3 @9 pto persist over 2009 to 2011. We anticipate that nationwide
* x; W5 T8 Q; D+ }6 Oresidential construction will fall further to around
$ ?5 b9 r- Y  ~: o* W, s1 ]  y125,000 starts over 2009 with a trough around 115,000 units
- ?6 \; U/ C2 D9 Xin the fourth quarter.
To quantify the degree of overpricing and overbuilding,
we first develop an empirical model, based on long-run
  ^0 Y2 U# [+ f( C4 f% z( t2 V% cfundamentals of house prices and housing starts in each
" `% c' X6 @+ q( W4 lprovince. 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
5 q- y- \$ [/ S; B& R0 Lregard housing prices and household formation as the drivers
* t- H6 v4 l) V. T+ wof residential construction.
: c& X! f0 ?0 u- eTo examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
. U9 x2 Y/ `2 _8 v6 _( Hoptimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
& z6 k5 d) Y6 aunits were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
) p& E0 {' A! `% C$ DRegionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
! p+ S1 d, b( R. K; Y, @population inflows. Saskatoon, Calgary and Edmonton are
% v: Q& J: ~3 g6 palready witnessing surges in their unsold new homes at the
very time that the resale market has swung into strong
" ~' y; ~: E  p% ubuyers’ 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
1 V9 o) G: i# w& ^' {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
( f7 T+ {3 Z/ @& s& n/ M1 scyclical downturn, the degree of structural weakness appears
& I! Q( H8 ?8 Tlimited – with the important exception of the Toronto
  y4 T9 D- L9 k! i( bcondo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
* a( k! l) m/ @; nconstruction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
% C3 l# y3 o, }4 v1 O7 \. ?+ Ccyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
1 e2 f) f) g9 Xresidential 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
; a  S" ^8 ^3 C  Z) y* E& s0 _years, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
& J: d1 ~* B; b; T# H; `& T# z( COVERPRICED AND OVERBUILT: CANADIAN HOUSING
: B; H; e' m/ \$ U5 n" g5 ~4 Z" g( LMARKET RETURNS TO FUNDAMENTALS
  D6 P; u% c1 \8 R0 w' N  qGrant Bishop, Economist
416-982-8063
% k5 U$ F" s# E% r* OPascal Gauthier, Economist
416-944-5730
) w) A- ]% j' S' B/ N$ r# G( z
. {" m" q3 n- u% u- Chttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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