TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
& [1 R0 Z) P$ h2 q+ S! _3 Q& L' A" L9 ufrom 2002 to 2008, unsustainable price increases drove
) G. Q7 h6 p. k" Dunsustainable levels of building. Our view is that house
8 L+ Q* v  v' T* G2 gprices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
5 `1 S( h7 Z0 l! ~& {that exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
4 J: }& h+ w7 D# ]three years.
By “overpricing” we mean that prices detached from
, E# b. g3 q5 Y  ltheir fundamentals, as witnessed by a steep erosion of
2 O+ Z3 f! @' ]* _6 ?- c  ~! raffordability. The current unwinding of house prices reflects
both a cyclical downturn and a return of house prices
to fundamentally justified levels.
; z9 Y: h7 k, f% u6 |7 g* i. uWe consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
0 \* [( }7 @0 n1 a6 |7 Z7 ]' Lthat this demand cannot be sustained; and “supply-driven”
/ x$ ^# ?7 l9 u+ @5 |where builders accumulate excessive inventories. Although
' n/ t2 ~9 Z) @% Z, F* lthere is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
" @4 i+ L. q8 Mhomebuyers pushed homebuilding to an unsustainable pitch
0 y2 \$ [$ X4 \9 T# H3 j0 N2 ~9 Uthat is now being rapidly reined in.
( r' o( L$ p9 H' _5 HWhile most markets won’t face U.S.-style overhangs,
the construction of too many new homes over the boom
. M* P% o1 e( l0 N' bmeans a deepened slump. This overbuilding will likely weigh
8 ~" |$ i: A" G% L* con markets over the next few years. Even as Canada recovers
from the cyclical downturn, house price growth will
, U9 B* ?+ ~' p0 Gremain choppy and new residential construction will be
# ]( ^2 z. w9 P& x" i3 C, ~( Udampened, owing to this structural weakness. Construction
! C( E8 P* N/ m& _( dis now undershooting fundamentals and we expect this
6 M# W: k: T  c3 xto persist over 2009 to 2011. We anticipate that nationwide
6 q+ l% }$ y8 |: C* Presidential construction will fall further to around
, k; @: S! A8 t7 Y7 G125,000 starts over 2009 with a trough around 115,000 units
% q. z" B* `" Z+ n3 Din the fourth quarter.
To quantify the degree of overpricing and overbuilding,
( q& f9 s( i' J' l7 ~/ z, Jwe first develop an empirical model, based on long-run
fundamentals of house prices and housing starts in each
5 k0 n, [! E" S8 Y* Z/ M: Iprovince. Affordability is the key concept behind home
values since house prices should track incomes over the
1 @; ]& s& |+ ?7 n) w1 s5 flong-run. Since homebuilders build to meet demand, we
regard housing prices and household formation as the drivers
. N3 ?3 A; q$ ]5 V' Yof residential construction.
  u) n' o  |  k) J7 f9 k0 G# p' ?6 ^' dTo examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
! F3 ?$ I5 f9 efundamental-justified level by about 12%. Although new
( E5 w! j! O6 Q& e9 `1 t5 Uunits were being absorbed, homebuyers simply bought too
5 y8 q0 g2 ], x- F& Ymany houses at prices that exceeded fundamentals.
2 S( B( X6 o$ a% Y" Q2 k  n) U8 JRegionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
+ ~" v3 c: s4 f+ U. \population inflows. Saskatoon, Calgary and Edmonton are
  D/ b2 C: n/ N9 kalready witnessing surges in their unsold new homes at the
very time that the resale market has swung into strong
) _  v8 o- P% q5 fbuyers’ territory. Homebuilding in the Atlantic provinces
2 {5 K. S7 G" x0 H. E5 @8 j0 }) Shas been relatively balanced but, while not plagued by structural
weakness, will be singed by the downturn nonetheless.
) c. i$ m' [8 e; [% }Québec shows signs of strain – especially given the
4 K) x+ D* R( t+ e$ r1 [4 Nstrange accumulation of unabsorbed multiples on l’Île de
Montréal – but recent building has been relatively balanced,
4 J$ p# U* u) c5 |0 ^$ cgiven the province’s history of under-building and low ownership
/ H1 l) p% U/ K1 ^rates. While Ontario homebuilding will reel from a
$ @# x: N, J, wcyclical 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
0 K. {: {0 \" Y! I7 cconstruction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
, g, N* x5 B) X$ @8 [cyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
# J6 V7 k0 S2 J- f% Jresidential construction in B.C. will definitely droop, we
anticipate 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.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
7 y4 ^1 t- j8 G. i# EMARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
/ [: ?2 W% t  Z& @7 a416-982-8063
Pascal Gauthier, Economist
416-944-5730
2 W2 d* `' T9 \5 F. |- ^
http://www.td.com/economics/special/gb0409_housing_exec.pdf

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