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
' ~0 |1 i3 Y( X; t! q/ Mfundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
+ [) q8 q! e/ N& Ythat 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
their fundamentals, as witnessed by a steep erosion of
( p4 @- G3 _) Raffordability. The current unwinding of house prices reflects
both a cyclical downturn and a return of house prices
) ~" u6 B1 P6 q% }) Ito fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
' \- i! V3 M; m( i2 hthat this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
5 k) w# u# i! B7 h) y9 |0 S( C# qhomebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
0 y& O( i9 C2 D' EWhile most markets won’t face U.S.-style overhangs,
  v; n. q. {1 J( \the construction of too many new homes over the boom
means a deepened slump. This overbuilding will likely weigh
) U; P0 A& C% ~# v# _, K5 mon markets over the next few years. Even as Canada recovers
1 y5 i, X4 Z- |, W0 nfrom the cyclical downturn, house price growth will
  W* S/ [" ]2 }& aremain choppy and new residential construction will be
" d/ }5 x! a4 R" U' C9 {0 g3 }4 Hdampened, owing to this structural weakness. Construction
% e9 ]& g. E/ N9 q# U! C, ^is now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
residential construction will fall further to around
, L8 s. O# ?0 G5 a3 o+ `1 L" v# }, T125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
" g: n5 M8 N* h  K& k6 yTo quantify the degree of overpricing and overbuilding,
2 |$ f6 Y9 H" ewe first develop an empirical model, based on long-run
& ^: E. M( y0 {5 ~6 Y; Ufundamentals 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
  M% l0 m! B1 M# ]/ wlong-run. Since homebuilders build to meet demand, we
9 a& h% w$ i3 o/ P3 d$ e1 J+ lregard housing prices and household formation as the drivers
8 S' l- @! u& t9 t! Dof residential construction.
7 P, j2 a2 ~# {, JTo 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
fundamental-justified level by about 12%. Although new
- O" }( i, w+ p, j& J8 ]units were being absorbed, homebuyers simply bought too
0 O* m) k3 |  J' Qmany houses at prices that exceeded fundamentals.
) P  I, |5 S# E2 X, U) xRegionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
! \8 a$ l! K, g0 [4 Hpopulation inflows. Saskatoon, Calgary and Edmonton are
& S9 H* f  s# _7 E  p" v2 m$ ialready witnessing surges in their unsold new homes at the
very time that the resale market has swung into strong
* I* h$ E; u# Y: N  j1 _6 }# E9 O- tbuyers’ territory. Homebuilding in the Atlantic provinces
# `( c) r; k$ q$ Qhas been relatively balanced but, while not plagued by structural
weakness, will be singed by the downturn nonetheless.
$ i1 r9 b7 [/ k# [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,
! D8 Y9 Y/ S. }# Y- u7 N0 ugiven the province’s history of under-building and low ownership
rates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
& V6 Q! \/ i1 A8 Y0 z7 h! E6 z# olimited – 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
/ j8 G7 p) |* G2 q) H5 ]& Zreach completion during 2009. If absorption rates fall, as
6 c2 |  D* Q$ _# y6 {- bcyclical factors would indicate, condo inventories could
5 ?% ?- v5 G+ Z9 Yspike severely – particularly in Vancouver. However, while
4 E" i& V0 h4 \  \7 b5 Q& p/ ]1 Vresidential construction in B.C. will definitely droop, we
" _* M& f( }6 Uanticipate that the West Coast will continue to benefit from
  C/ F2 B" ^2 S, }) c* [/ I0 |inter-provincial and international migration over the coming
+ Y* k1 @, u2 jyears, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
, c% n9 B2 K9 S8 C0 HPascal Gauthier, Economist
416-944-5730
* O) F/ E, M5 H/ ^7 v3 B
http://www.td.com/economics/special/gb0409_housing_exec.pdf

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