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
' p: L1 C2 J% {3 I: Eunsustainable levels of building. Our view is that house
$ X# ]( ~6 R2 l& G2 U. z+ Uprices exceeded the value of housing that was justified by
/ [+ Y; D: v. z$ K. \+ bfundamentals by approximately 9% nationwide. This
* u. M4 Z7 [$ @! k3 ?( soverpricing compelled a level of residential construction
+ f/ o6 u) a7 L+ j- k& ?that exceeded its fundamental-justified level by approximately
$ `( M& @/ G7 a12%, an excess that was exaggerated in the past
4 w' e% @8 w( V) pthree years.
By “overpricing” we mean that prices detached from
( F) b+ Z% G& P, |their fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
# Z+ ^6 b) z, {% N- d. vboth a cyclical downturn and a return of house prices
: t6 o/ G& X1 D2 Dto fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
4 w" Z( ~, u0 {3 y. ~that this demand cannot be sustained; and “supply-driven”
. \3 A, u! @, q3 k# m- G3 o4 s5 dwhere builders accumulate excessive inventories. Although
: m8 J2 A0 N5 P( F6 A# M# hthere is evidence of both types, we contend that Canada’s
. W3 T" S9 O6 D2 K5 Z! X- W! ~“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
# g8 t0 ^0 l( ?- l' F/ m4 e+ W; Y+ G4 ?While most markets won’t face U.S.-style overhangs,
& ^9 L& k7 ^4 V! @" bthe construction of too many new homes over the boom
means 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
remain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
9 B' R# B5 F' Y9 P0 Lis now undershooting fundamentals and we expect this
6 O7 X0 H- C9 p/ Y' C3 eto persist over 2009 to 2011. We anticipate that nationwide
residential construction will fall further to around
1 j4 |5 q0 k( D: ~% M! b4 C125,000 starts over 2009 with a trough around 115,000 units
( w* }* U' \( C1 F6 k/ Qin the fourth quarter.
$ q" X8 ]/ `" k0 y2 _: U2 x+ gTo quantify the degree of overpricing and overbuilding,
$ S8 y6 g) w% ^* ^we first develop an empirical model, based on long-run
fundamentals 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
regard housing prices and household formation as the drivers
5 Z& P+ b  i/ Wof 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
6 G  Y7 }: b9 S# ]6 Coptimally. We find that actual homebuilding exceeded this
8 [! n2 \; m! ]fundamental-justified level by about 12%. Although new
! |2 a4 h8 z; J+ runits were being absorbed, homebuyers simply bought too
& a- j+ g$ F$ ?+ z! tmany houses at prices that exceeded fundamentals.
7 I) t" e" N; S2 FRegionally, we see the greatest strains on the Prairies,
* \# a# `9 ~; }: \: x# A, M" Twhere housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
9 d$ }2 ~. y% B- s6 {3 ralready witnessing surges in their unsold new homes at the
very time that the resale market has swung into strong
* E; n* V+ x: [8 M; Rbuyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
& e6 x5 \4 Q' m" s# ?, Qweakness, will be singed by the downturn nonetheless.
. |/ @0 @+ E/ ]# m: I9 y9 T5 p. G0 vQuébec shows signs of strain – especially given the
$ u! v2 _+ ?1 U. }6 {strange accumulation of unabsorbed multiples on l’Île de
" M7 B  L6 x( G" N8 _6 s+ F& `  @Montréal – but recent building has been relatively balanced,
( @2 K& M2 F% I: E$ N; agiven 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
limited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
, K8 A# B) h  N8 s( zhigh levels of apartment-style units presently under
6 m  F9 o/ W$ G6 J2 ]7 O# R# Iconstruction mean that record numbers of condos will
& I% b$ c- p9 u  \/ S$ Areach completion during 2009. If absorption rates fall, as
3 L1 N/ |+ D- b& Fcyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
' l3 ~5 |9 u. ?0 r3 q+ uresidential construction in B.C. will definitely droop, we
anticipate that the West Coast will continue to benefit from
. F, i7 R; t% B! ]5 |inter-provincial and international migration over the coming
. ^4 H2 X* x6 D, l$ Vyears, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
8 k, q$ d9 a1 z$ Q# f0 ^MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
8 v- k, Z0 G& R+ ~416-982-8063
Pascal Gauthier, Economist
416-944-5730

0 _9 O6 _. B9 s3 c- ]http://www.td.com/economics/special/gb0409_housing_exec.pdf

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