TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
& H, E; F7 r; z) k# J% ]from 2002 to 2008, unsustainable price increases drove
% f8 ~2 X! h; p- l) @unsustainable levels of building. Our view is that house
9 n0 }! E( Z, r/ oprices exceeded the value of housing that was justified by
3 ?  ?; Z$ {5 P/ T% g& wfundamentals by approximately 9% nationwide. This
0 F# `5 V1 f) c3 c+ |3 ?overpricing compelled a level of residential construction
! }% ~# d4 O$ s" X9 _2 W# z" qthat exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
three years.
3 D! x4 m. X' X9 W  ^  @2 bBy “overpricing” we mean that prices detached from
4 t% {- k/ o3 ?% ztheir fundamentals, as witnessed by a steep erosion of
, v/ h, J% p! B; j: d0 ]affordability. The current unwinding of house prices reflects
both a cyclical downturn and a return of house prices
: v- ^& s# c0 D3 K4 `! kto 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”
where builders accumulate excessive inventories. Although
2 \, x, q; \7 f. b5 E7 `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.
While most markets won’t face U.S.-style overhangs,
" m" ]/ T" [0 n. Rthe 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
2 n/ g* X; K: D2 u  N4 Wis now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
# C* n) e  C0 J$ z1 v: {residential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
To quantify the degree of overpricing and overbuilding,
we first develop an empirical model, based on long-run
fundamentals of house prices and housing starts in each
: E3 F% [3 [5 d# |3 \province. Affordability is the key concept behind home
" W  L4 \' x# F6 ^/ b. I0 D: Nvalues since house prices should track incomes over the
! m" `3 R* A1 X0 J3 Elong-run. Since homebuilders build to meet demand, we
regard housing prices and household formation as the drivers
5 F/ S6 I9 `$ d! W/ @' G% q0 Dof residential construction.
To examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
0 C( |! a  _) h* Qwould have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
3 j5 }5 x1 c3 r7 G! T4 |6 gmany houses at prices that exceeded fundamentals.
! }6 _# A; L, W2 }- oRegionally, we see the greatest strains on the Prairies,
% n, B6 m4 d/ W0 {9 d9 B2 r0 hwhere housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
very 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
weakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
strange accumulation of unabsorbed multiples on l’Île de
9 c- ~: q6 s( K, K" P9 `2 w5 [Montréal – but recent building has been relatively balanced,
given the province’s history of under-building and low ownership
( X3 f* {0 a( y2 Q+ [rates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
2 q9 ]. W' a. x# W& d8 f' ~limited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
9 p8 i0 |3 o! K* l2 [# mconstruction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
) m+ N" Z3 E! Yspike severely – particularly in Vancouver. However, while
# }* j: p7 y) f" U9 o0 sresidential construction in B.C. will definitely droop, we
anticipate that the West Coast will continue to benefit from
: r4 r' ^2 i2 V3 u- linter-provincial and international migration over the coming
' t2 {) T, g' k2 w$ t- qyears, which, along with improvements in affordability,
/ i( X' P+ \3 \$ I7 L5 E: J8 xwill alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
+ |9 {& i) l5 {7 HMARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
' i6 S2 J6 V0 _* V416-982-8063
" d- Z. l0 T( KPascal Gauthier, Economist
416-944-5730

http://www.td.com/economics/special/gb0409_housing_exec.pdf

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