TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
2 Z2 w  w: O7 J5 G7 N7 t) y3 |from 2002 to 2008, unsustainable price increases drove
1 M+ b& ^0 L" _: X. Dunsustainable 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
that exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
" N% _1 Z$ y3 ^# }; uthree years.
% V% o. B2 g( s& XBy “overpricing” we mean that prices detached from
4 [) ?) b  U( b( X# C" e: X4 `; qtheir fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
6 `& V$ v3 Z/ t) v4 J: u- V' E$ vboth a cyclical downturn and a return of house prices
to fundamentally justified levels.
" [1 T+ V* q! Z0 h3 o- gWe consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
/ P$ `: R" y0 q9 j+ x: [where builders accumulate excessive inventories. Although
0 H* X9 R; K) h0 e' N5 d& i  b# h8 ithere 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
that is now being rapidly reined in.
; t3 b$ I6 X4 C# O3 AWhile most markets won’t face U.S.-style overhangs,
6 o1 n6 ^$ q4 N/ D/ d  y6 u6 Wthe construction of too many new homes over the boom
means a deepened slump. This overbuilding will likely weigh
/ }* }9 x* n+ l) Q5 ]6 \$ U/ T, o# ]  ton markets over the next few years. Even as Canada recovers
from the cyclical downturn, house price growth will
remain choppy and new residential construction will be
& _8 c7 i% U+ H' P+ S* G  a2 e+ V/ ]2 ldampened, owing to this structural weakness. Construction
" G! v* v1 \" V, f7 o" C5 M: \is now undershooting fundamentals and we expect this
" K- R# Z/ O$ G, E! Y1 ~  vto persist over 2009 to 2011. We anticipate that nationwide
residential construction will fall further to around
) u6 {# n3 S7 _3 i125,000 starts over 2009 with a trough around 115,000 units
& j1 o4 l1 b: M, X/ e# }in the fourth quarter.
To quantify the degree of overpricing and overbuilding,
we first develop an empirical model, based on long-run
, J' M) }8 q  ~* u9 V) jfundamentals of house prices and housing starts in each
province. Affordability is the key concept behind home
$ A) ~" |( U! A+ Uvalues since house prices should track incomes over the
long-run. Since homebuilders build to meet demand, we
5 i5 X* o0 G) _) k$ r/ nregard housing prices and household formation as the drivers
) Y9 ^) e+ B, m5 H2 F& g  A3 a3 Gof residential construction.
To examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
# W9 Z' i. M" U! B( d3 U& ]' V; V2 [would have occurred if housing had been priced
; X6 O# p3 |& p- H) R5 L4 Joptimally. We find that actual homebuilding exceeded this
  D% S# ]) f: K4 qfundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
7 X6 S2 k& _9 u7 d$ M% Gmany houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
: g% \* R- ~9 _) v7 `population inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
7 L; l- b& a4 N: A: I+ u& \! g/ yvery time that the resale market has swung into strong
- [- S* C* e1 {! ?  hbuyers’ territory. Homebuilding in the Atlantic provinces
/ L) N+ F: i0 Z8 l# p# T$ Khas been relatively balanced but, while not plagued by structural
$ U, C5 c5 A0 E2 sweakness, will be singed by the downturn nonetheless.
' K; N; E1 `; G* LQuébec shows signs of strain – especially given the
strange accumulation of unabsorbed multiples on l’Île de
" l% R9 J1 o& ~( h4 lMontréal – but recent building has been relatively balanced,
+ @( X3 l6 W5 [% X( q" mgiven the province’s history of under-building and low ownership
# e& }, u7 g  R/ trates. While Ontario homebuilding will reel from a
cyclical 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
construction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
# Q# I; D' _" x) S- M1 b% Z2 Qcyclical factors would indicate, condo inventories could
& j; ~% F# j$ }1 Yspike severely – particularly in Vancouver. However, while
0 U) [. I4 W) M* E  bresidential construction in B.C. will definitely droop, we
$ G7 i/ _8 |3 L/ ]; g- {, ~  ganticipate that the West Coast will continue to benefit from
% f' I7 Q" c, d! j0 _inter-provincial and international migration over the coming
years, which, along with improvements in affordability,
( M4 A* o: B1 I4 y/ }/ `; awill alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
" O8 h+ y0 }) e& {7 @8 }+ EGrant Bishop, Economist
416-982-8063
Pascal Gauthier, Economist
416-944-5730
# u& {- \* r' J$ N! c; C
http://www.td.com/economics/special/gb0409_housing_exec.pdf

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