TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
( ]; V) Y6 P$ Y: V, w& K' h% G- j# zfrom 2002 to 2008, unsustainable price increases drove
  _/ n4 T, n) C: |! J  h4 xunsustainable levels of building. Our view is that house
! K' W1 Y# y* ?# z8 e# V' w. P9 ]  ?prices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
5 i0 L- q6 h- K8 i# F8 bthat exceeded its fundamental-justified level by approximately
, J) t7 _7 [5 a% g* x12%, an excess that was exaggerated in the past
0 m# U6 a2 @  Fthree years.
# ?' z; p$ ?0 {4 s4 h% Y  N  k! L. dBy “overpricing” we mean that prices detached from
" d6 V7 x) E4 Htheir fundamentals, as witnessed by a steep erosion of
( }# I& e: T/ E: S% y& Q2 {affordability. The current unwinding of house prices reflects
. J  j+ J7 d  e$ lboth a cyclical downturn and a return of house prices
to fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
' _$ H+ t7 q! {' Athat this demand cannot be sustained; and “supply-driven”
; I' W- [, j4 J$ Lwhere builders accumulate excessive inventories. Although
8 A$ |* Z0 `5 W, M+ M3 O; Ithere is evidence of both types, we contend that Canada’s
- Q* Z, L4 O& j  V! E* F“overbuilding” was mainly of the first type, where
' }1 O8 u" i8 p3 u2 V0 j. Nhomebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
; Y4 w3 f* ~, athe construction of too many new homes over the boom
) @0 H1 A7 @6 S  D" I3 n2 wmeans a deepened slump. This overbuilding will likely weigh
1 ~9 c  `& z. z7 `, Mon markets over the next few years. Even as Canada recovers
/ B. q' _" E4 I: F7 |/ G* {from the cyclical downturn, house price growth will
remain choppy and new residential construction will be
5 P5 d) t: z6 I( W  y+ ^dampened, owing to this structural weakness. Construction
& b0 E8 y2 W2 s& q; kis now undershooting fundamentals and we expect this
9 u% D$ L& g- x, ]( lto persist over 2009 to 2011. We anticipate that nationwide
7 F  X2 G. ~3 @. ], l3 _9 |* Xresidential construction will fall further to around
$ V6 x+ r  Y9 ~4 B125,000 starts over 2009 with a trough around 115,000 units
+ k& h. b1 d! ]  Tin the fourth quarter.
8 C! H4 h" u. f4 f  S" `To quantify the degree of overpricing and overbuilding,
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
& o, ?& t- [: N$ k; ]+ t. elong-run. Since homebuilders build to meet demand, we
+ e0 Z: i  H# \6 Pregard housing prices and household formation as the drivers
9 @; l" {9 T9 r3 W' X5 y5 }of residential construction.
' S' v* W. T1 MTo 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 D% {3 I) [# M( J" |optimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
) m$ }7 O# o) w; p/ a) v* Uunits were being absorbed, homebuyers simply bought too
9 `  H9 o0 _% lmany houses at prices that exceeded fundamentals.
0 P; Z/ c2 Q1 JRegionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
- ]" S  T  `% h5 `! spopulation inflows. Saskatoon, Calgary and Edmonton are
- ~! p2 b! [" s+ z, t- P% nalready witnessing surges in their unsold new homes at the
very time that the resale market has swung into strong
& X, n/ E0 x6 d9 a: X, Y% _; Kbuyers’ territory. Homebuilding in the Atlantic provinces
$ D, X0 Y' B' P3 Z7 Z4 _. s7 [has been relatively balanced but, while not plagued by structural
weakness, will be singed by the downturn nonetheless.
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,
! _* v4 @- B6 \" [$ }* Z) O6 tgiven 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
0 u. f8 p/ X5 @/ n8 nlimited – with the important exception of the Toronto
  m  o( ?  R/ d7 _) h$ r. s2 x# J8 [condo market. Both in Toronto and Vancouver, historically
  {# F* L, _3 n3 g, Uhigh levels of apartment-style units presently under
7 `2 X/ k6 i, h/ [& |construction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
+ \# Q" q# u" aspike severely – particularly in Vancouver. However, while
residential construction in B.C. will definitely droop, we
  z3 c  Y6 _* i9 x0 Ranticipate that the West Coast will continue to benefit from
( o/ q( s2 C. H7 @* jinter-provincial and international migration over the coming
# t1 a; e( V& |% Dyears, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
9 m% H0 B8 i, J9 Z  o3 Q" x' F# PGrant Bishop, Economist
416-982-8063
% w" z9 q; G/ s; z! V9 `" n1 aPascal Gauthier, Economist
416-944-5730

, m- x" F5 K* k+ G7 L6 n! x; T% ~1 }http://www.td.com/economics/special/gb0409_housing_exec.pdf

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