TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
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
; k: |" [, w6 C- _' koverpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
' Y1 B& [7 B2 m& w5 S/ F) E, N12%, an excess that was exaggerated in the past
" U# n  y6 W& H9 `: r8 Hthree years.
3 w1 a4 r: U3 }By “overpricing” we mean that prices detached from
7 q; |6 J. U" i& p" Y0 ?6 |their fundamentals, as witnessed by a steep erosion of
0 t( t( j* y7 X; Laffordability. The current unwinding of house prices reflects
/ o1 O, q) e& n2 P; O) A' Vboth a cyclical downturn and a return of house prices
to fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
/ n7 p( C+ t, l& A& j! \3 M% Vwhere homebuyers buy up too many houses and
2 M% A# ^' u# Hthat this demand cannot be sustained; and “supply-driven”
; T) F, F' u" ~7 Zwhere builders accumulate excessive inventories. Although
* ^" P- e% m$ V+ `2 X7 [/ }there is evidence of both types, we contend that Canada’s
2 o* J9 a, r1 T7 P“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
! r1 m& e8 E  W1 m  A' u+ N0 pthat is now being rapidly reined in.
% ]& p+ j7 V! B. CWhile most markets won’t face U.S.-style overhangs,
the construction of too many new homes over the boom
. j( p% s9 v! W3 H/ p+ ?* jmeans 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
1 J3 K* U7 e+ jremain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
% Y# R- D) R- S5 Q: C  _! Ais now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
3 R2 Y4 N: @; K3 O+ Cresidential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
  ]5 t& w) L( e- G9 V+ Win the fourth quarter.
To quantify the degree of overpricing and overbuilding,
we first develop an empirical model, based on long-run
0 o7 g6 {$ z% T8 O) @6 dfundamentals of house prices and housing starts in each
3 v( v/ ]5 V, f& q3 Rprovince. 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 x6 P+ _" p1 u# \  aregard housing prices and household formation as the drivers
1 ^# }' M9 Q. y5 l7 ?* aof 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
* Z  K- I, S8 o1 f6 i0 W( F9 d) Koptimally. We find that actual homebuilding exceeded this
' M9 `6 R& r4 I8 n8 }# A) qfundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
: Z4 Y) |* \& t3 @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
$ e, v7 a+ ]2 Z9 Lweakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
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
2 E6 X* C  T- J) `rates. While Ontario homebuilding will reel from a
% k6 Y% X" g4 a5 P! x& i7 N2 {+ Ycyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
; |2 y% [  i0 v& D: z% acondo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
construction mean that record numbers of condos will
  l+ P2 Q' `" r8 v, l1 ureach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
2 E9 `5 M/ |3 U* H9 S9 T1 l& Ispike severely – particularly in Vancouver. However, while
residential construction in B.C. will definitely droop, we
anticipate that the West Coast will continue to benefit from
; i  V3 P: y( n, g- U! Yinter-provincial and international migration over the coming
6 i3 d  i: ~) _* H3 D/ l3 [years, which, along with improvements in affordability,
+ R* Y' W! a6 J" }* A+ k: Owill alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
/ R. @& z6 {3 O2 g7 N0 GMARKET RETURNS TO FUNDAMENTALS
  v+ {3 \! m- i% PGrant Bishop, Economist
; f! d+ k8 Y, ]& P2 J, q416-982-8063
Pascal Gauthier, Economist
8 M8 _* N& s! z- J4 @; {' y, S416-944-5730
. S0 e! f& i$ s' R
& k$ W6 Y5 ?" K1 Y6 B. Z4 N: v/ Khttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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