TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
; m. W4 }. p/ ifrom 2002 to 2008, unsustainable price increases drove
, z0 u' ^% y$ Q" L: K- v$ vunsustainable levels of building. Our view is that house
+ ?* B% a, b1 C/ }# J: Fprices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
5 b# F# Z" [6 b$ Z( E1 i. cthat exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
three years.
By “overpricing” we mean that prices detached from
7 z3 ?2 O4 X9 B4 Rtheir fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
  L+ |7 G( j# N+ \' qboth a cyclical downturn and a return of house prices
to fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
3 x# T* r2 `8 |  h# Rwhere homebuyers buy up too many houses and
2 Z) B2 ^( |% `8 M1 |/ |% mthat this demand cannot be sustained; and “supply-driven”
; h3 [# \% ?; Ewhere builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
! V; i$ w. D, U* H1 f% a“overbuilding” was mainly of the first type, where
, d) p( x% V! R0 J2 Qhomebuyers pushed homebuilding to an unsustainable pitch
' N7 s, v" g9 x# \. q2 Bthat 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
means a deepened slump. This overbuilding will likely weigh
" a8 f, a4 `4 P& Non markets over the next few years. Even as Canada recovers
$ R. R5 C) O7 Afrom 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
' w7 k! ]8 D1 U- A& o7 f) n& Hto persist over 2009 to 2011. We anticipate that nationwide
residential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
3 B4 u! d1 k, K$ R2 [6 b  e& h2 zin the fourth quarter.
To quantify the degree of overpricing and overbuilding,
! P- g3 x: {" ?* p# Rwe first develop an empirical model, based on long-run
fundamentals 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
/ j0 W! F' U' S5 a% ~of residential construction.
( L  y/ ^7 N: B$ E9 k1 d( X% OTo examine the degree of overbuilding, we employ a
5 _8 e8 j8 d6 X( m“counter-factual,” asking what level of residential construction
! K0 V/ u+ M5 W! Wwould have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
1 z$ k' b# U7 u! Mfundamental-justified level by about 12%. Although new
' P* ~" p/ u. n* qunits were being absorbed, homebuyers simply bought too
0 F3 U# q5 _3 n# C) pmany houses at prices that exceeded fundamentals.
8 F( {% i  S; Y: Y9 W& m: fRegionally, we see the greatest strains on the Prairies,
0 X% O( u9 g/ x, M% Swhere 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
+ S% `' E2 v2 fhas 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
5 ^+ x4 f. A  n0 F5 R) |0 zstrange accumulation of unabsorbed multiples on l’Île de
( W6 D; S+ w, Z& EMontréal – but recent building has been relatively balanced,
given the province’s history of under-building and low ownership
' Z" n4 c, M% r2 Erates. While Ontario homebuilding will reel from a
7 z5 d6 V0 d/ u( _2 m9 lcyclical downturn, the degree of structural weakness appears
4 f+ [3 W& J' o% Q. O+ alimited – with the important exception of the Toronto
: h8 h  q9 Z3 q, u$ m0 tcondo market. Both in Toronto and Vancouver, historically
& c# [; U6 p9 s( x- ]high levels of apartment-style units presently under
construction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
! w* m. ?& ~  P4 }! a: r. U8 jcyclical factors would indicate, condo inventories could
0 R4 m+ p. ]9 T1 I, j* X& @* T; nspike severely – particularly in Vancouver. However, while
; S, p- }4 b4 d' oresidential construction in B.C. will definitely droop, we
2 }) g" |) X3 D, U, vanticipate that the West Coast will continue to benefit from
inter-provincial and international migration over the coming
years, which, along with improvements in affordability,
$ H8 M1 A) b8 E) l9 y+ O) n- v1 Bwill alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
) r: k- R( K6 B* CMARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
Pascal Gauthier, Economist
+ ^* J2 O- B3 g/ T3 O$ [4 d" b416-944-5730
  Z5 ~4 f, f0 D5 V. h
, j& Z6 b: ?8 M3 _) V: dhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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