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
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
* Y( c% ?5 h" u  {three years.
: ?0 e0 \8 o0 @% x5 w) O/ `: PBy “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
4 k3 O: ~6 ^! D: f8 G# gboth a cyclical downturn and a return of house prices
to fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
, K. {' g  E  v# A, |3 W# ]# `2 [where homebuyers buy up too many houses and
$ F1 _  q* b" w* ?3 O/ j- O7 i0 Gthat this demand cannot be sustained; and “supply-driven”
! R% C: Y! r; C' i! F' Nwhere builders accumulate excessive inventories. Although
  \* ~4 J3 |) ^there 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
& t6 J" K* ?( L  _: rthat is now being rapidly reined in.
8 D& M0 b( }4 v2 bWhile most markets won’t face U.S.-style overhangs,
' F4 H. Z) ]" }: R3 g& q/ xthe construction of too many new homes over the boom
; N1 t  H% \+ k/ dmeans 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
! N& h# s6 V& d- Hdampened, owing to this structural weakness. Construction
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
" X  D1 O9 D" Q4 x125,000 starts over 2009 with a trough around 115,000 units
- g' N1 X+ j9 m" b/ ?) Hin the fourth quarter.
To quantify the degree of overpricing and overbuilding,
$ U; u* \& ^* i, iwe first develop an empirical model, based on long-run
$ w5 _# K  c$ W* ^9 a/ ?9 pfundamentals of house prices and housing starts in each
  k1 `. H5 M  J& ?6 `province. Affordability is the key concept behind home
# ]# @" P  O# ^9 z- k8 e& Nvalues since house prices should track incomes over the
" W- a" k$ m. |& p+ R' t4 u! t0 f$ Hlong-run. Since homebuilders build to meet demand, we
regard housing prices and household formation as the drivers
: X( V1 J* y* \of residential construction.
To examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
! B$ j) R* O/ b$ R) bwould have occurred if housing had been priced
1 K7 \2 S1 N; T& }optimally. We find that actual homebuilding exceeded this
  x7 C" `" m- q+ g8 mfundamental-justified level by about 12%. Although new
( s" L: b2 L5 Zunits were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
" `% N3 ]4 H, W1 r1 mRegionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
* W8 l6 [% ^" ~already 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
4 j5 n- F+ x5 u& h6 mhas been relatively balanced but, while not plagued by structural
, U4 X1 I% k& [% i2 H3 a6 Z) q; Aweakness, will be singed by the downturn nonetheless.
+ G6 K% h/ G% DQuébec shows signs of strain – especially given the
strange accumulation of unabsorbed multiples on l’Île de
Montréal – but recent building has been relatively balanced,
; N: g2 f* w2 r+ x6 x& X% Hgiven the province’s history of under-building and low ownership
rates. While Ontario homebuilding will reel from a
0 J( A6 B- D. _; ^' Bcyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
( l5 G. ?: s  w. K- w" acondo market. Both in Toronto and Vancouver, historically
1 J% p% v; x) U# D. Q; Vhigh levels of apartment-style units presently under
construction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
& m% P1 r% Q/ m2 @( rcyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
5 |: \  I1 @( f# O; u/ P3 r7 nresidential construction in B.C. will definitely droop, we
anticipate that the West Coast will continue to benefit from
* t& @$ q7 `: l: jinter-provincial and international migration over the coming
years, which, along with improvements in affordability,
; u; T- s: s5 ~) h+ u; Vwill alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
' B8 v* S9 M8 I) e  t: gMARKET RETURNS TO FUNDAMENTALS
5 H( Z* _/ U4 J! J2 y" Z# q; W* MGrant Bishop, Economist
416-982-8063
Pascal Gauthier, Economist
8 J. ~; f) ]$ x+ X416-944-5730
* i0 [4 `6 M% H& y
# i" A# h1 d/ N' t' Whttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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