TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
, m# Q/ L4 i9 e( cfrom 2002 to 2008, unsustainable price increases drove
unsustainable levels of building. Our view is that house
3 o+ \/ u/ M+ @. v3 O" a, Uprices exceeded the value of housing that was justified by
: p7 X0 f- P) a7 \4 b4 yfundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
  X& ~4 v' B3 uthat exceeded its fundamental-justified level by approximately
  v8 ?; d. }2 s% b/ A12%, an excess that was exaggerated in the past
- e, D4 I. H& K* dthree years.
By “overpricing” we mean that prices detached from
( @4 X0 Q+ [1 t! Ptheir fundamentals, as witnessed by a steep erosion of
  f: F0 q8 |- }% |# Y$ xaffordability. The current unwinding of house prices reflects
3 ]8 m6 u0 r7 F+ Q$ W4 G# Vboth a cyclical downturn and a return of house prices
to fundamentally justified levels.
0 S6 d, W8 w7 j! n' R- F+ }We consider “overbuilding” of two forms: “demanddriven”
  Y9 }9 f9 [+ E, j0 jwhere homebuyers buy up too many houses and
7 t6 m3 n  s; F) c) zthat this demand cannot be sustained; and “supply-driven”
- w1 a" R5 B4 X8 Q- w( x' owhere builders accumulate excessive inventories. Although
3 T* j8 [" r# Mthere 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
& c4 u1 U# j' D6 s) o1 G4 L; ^4 ~that 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
! y: n3 m9 h1 non markets over the next few years. Even as Canada recovers
$ O# J$ m! K* Q2 P9 |3 [from the cyclical downturn, house price growth will
1 f4 U& g, {5 [: ]4 a& e6 kremain choppy and new residential construction will be
8 Z% o  @2 X; ^dampened, owing to this structural weakness. Construction
2 h1 k3 d6 R, c" S' ?) tis now undershooting fundamentals and we expect this
+ [' c/ r% C$ f' r" d3 I: Ito persist over 2009 to 2011. We anticipate that nationwide
: e# v) \7 P# \! N  L$ sresidential construction will fall further to around
3 u1 q/ _5 a9 d; L& |1 G4 ^125,000 starts over 2009 with a trough around 115,000 units
/ j) B' N5 n! L3 b6 @& F9 L3 Lin the fourth quarter.
To quantify the degree of overpricing and overbuilding,
# B, i7 ?/ f  Kwe first develop an empirical model, based on long-run
$ |7 U9 e) p" t3 ?; Jfundamentals 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
1 g) _/ W- D! Q& L% @7 l% C! A, b8 Q3 Sregard housing prices and household formation as the drivers
) E" p) H5 ~+ u! ^, T, `3 H% {1 t- [of residential construction.
8 M4 A  }& t0 C1 s+ o" O: O4 \) k. tTo examine the degree of overbuilding, we employ a
# h6 S% U% Q, b; G9 c“counter-factual,” asking what level of residential construction
8 o# `; K# ?4 V& |% X& Ywould have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
7 J' o' H) T( j: z' n7 |units were being absorbed, homebuyers simply bought too
- e$ f% o' t# D3 R) C- hmany houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
. o' ?" a$ v' C9 a; u, swhere housing demand will further contract under waning
& C1 `% q+ A9 upopulation inflows. Saskatoon, Calgary and Edmonton are
  }1 f. h% q- q* valready 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
! l" t$ j" k9 X" _$ Q' I2 Mhas been relatively balanced but, while not plagued by structural
weakness, will be singed by the downturn nonetheless.
; g: L' V. e7 i% f% ^Québec shows signs of strain – especially given the
) {+ N" |/ K  G. D' T' Kstrange accumulation of unabsorbed multiples on l’Île de
5 R" w: R7 Y. ]# HMontréal – but recent building has been relatively balanced,
given the province’s history of under-building and low ownership
5 x! n3 R) k) b+ _9 Brates. While Ontario homebuilding will reel from a
# X5 r7 S  p* V- A0 D  J% d( jcyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
1 h: i* u0 Y* L% ^0 i- q# p% fcondo market. Both in Toronto and Vancouver, historically
* e% U. J; c8 A$ E1 lhigh levels of apartment-style units presently under
construction mean that record numbers of condos will
8 j. R% X9 N0 Freach completion during 2009. If absorption rates fall, as
0 p9 r/ C! z9 l2 \* g" xcyclical factors would indicate, condo inventories could
9 N7 @, f( H6 Vspike 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
: H+ q+ v2 J; Z- W! ?0 w+ z) Finter-provincial and international migration over the coming
years, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
3 l0 K' P& X% E7 l7 AGrant Bishop, Economist
416-982-8063
Pascal Gauthier, Economist
  q; Q8 n* c6 H4 e7 {416-944-5730

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

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