TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
; |, U' H4 \, V! d* H8 Bfrom 2002 to 2008, unsustainable price increases drove
7 F. s7 w( u: E0 [3 k9 eunsustainable 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
2 M9 k3 k8 D2 a  Q7 Z. Cthat exceeded its fundamental-justified level by approximately
$ D8 K+ `4 U2 P" d, b( m$ X- ^12%, an excess that was exaggerated in the past
three 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
! }" \7 P2 U$ `' L. g3 d0 y3 s' w- ^$ oboth 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”
where builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
- u: \3 S5 t9 Q“overbuilding” was mainly of the first type, where
" j5 U7 _& m/ Q1 v) N4 q' o- F* whomebuyers pushed homebuilding to an unsustainable pitch
! _* }' W4 ?2 N. }- A* E, Xthat 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 g6 X) t6 v# Z( E/ |8 R2 l! Ameans a deepened slump. This overbuilding will likely weigh
on markets over the next few years. Even as Canada recovers
4 B: _8 J4 v; R8 X" mfrom the cyclical downturn, house price growth will
remain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
* t( c$ Y  Q4 Z- z' Z- I' ~6 \( Y' Kto persist over 2009 to 2011. We anticipate that nationwide
! V3 z! g, w* w% kresidential construction will fall further to around
* V3 ^% E" s; s' g4 e* L  t( _125,000 starts over 2009 with a trough around 115,000 units
7 l" Q& u6 P- n0 m8 }+ ?; cin the fourth quarter.
To quantify the degree of overpricing and overbuilding,
we first develop an empirical model, based on long-run
  r# E9 ~/ ^+ _! |3 Ofundamentals of house prices and housing starts in each
province. Affordability is the key concept behind home
; G" U4 `4 k- b  R- Q' G* Dvalues since house prices should track incomes over the
/ M6 t$ c  o, slong-run. Since homebuilders build to meet demand, we
6 N4 a; M9 p$ [  |+ }4 Cregard 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
% {$ k! A3 z* L7 d: C- ]# hoptimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
% v$ I5 `) |0 }' U9 K+ V+ R$ v# runits were being absorbed, homebuyers simply bought too
( O; }+ Y! f: {/ Dmany houses at prices that exceeded fundamentals.
4 V% j2 A6 n% l7 ?2 F7 x! @: mRegionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
) z0 Y$ d) V! {. S8 H9 ~already witnessing surges in their unsold new homes at the
very time that the resale market has swung into strong
/ s6 t3 L/ q8 m' S) ?+ Rbuyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
& R& ^+ y+ b) z* t! k1 l8 Fweakness, will be singed by the downturn nonetheless.
( K- u6 m& B! D' U% G7 DQuébec shows signs of strain – especially given the
strange accumulation of unabsorbed multiples on l’Île de
/ C7 p- ?. _- X! fMontréal – but recent building has been relatively balanced,
- w# l& k5 z  k/ k9 L5 l+ m  k3 X( w6 hgiven the province’s history of under-building and low ownership
rates. While Ontario homebuilding will reel from a
# G5 s8 C# x  C  p8 _, ycyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
4 ~" L7 u1 Z9 x9 n3 W: p% b$ ~8 ?construction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
5 J- s/ H! J6 Tcyclical factors would indicate, condo inventories could
2 h4 b* x1 s0 wspike severely – particularly in Vancouver. However, while
residential construction in B.C. will definitely droop, we
7 f* q, ]& A0 G% L5 ~  Danticipate that the West Coast will continue to benefit from
inter-provincial and international migration over the coming
years, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
: `! L/ J3 e. kOVERPRICED AND OVERBUILT: CANADIAN HOUSING
, z/ h1 [$ R$ l' d! o8 q% tMARKET RETURNS TO FUNDAMENTALS
" V( J" m5 g7 `* k) O4 L3 c/ OGrant Bishop, Economist
416-982-8063
. L; L& u- \5 k8 w5 Q7 |  jPascal Gauthier, Economist
416-944-5730

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

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