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
# v+ n# y7 ]# z  o$ \3 Y3 f& |prices exceeded the value of housing that was justified by
3 ^6 m+ n' n2 H. Efundamentals 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
three years.
  C) m0 m4 ]. k$ B5 IBy “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
8 U& J- [: T: q* h: gboth a cyclical downturn and a return of house prices
% G- N9 x) r; o+ B0 I% R2 rto fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
7 @4 i$ f5 s; _8 d' R/ J- zwhere homebuyers buy up too many houses and
: D( {5 M8 W/ X2 ^! {that 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
8 w9 V6 R2 N6 z3 O# b0 O) T“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
4 k& ^' m' `! C" P& I4 |/ \. g9 fWhile most markets won’t face U.S.-style overhangs,
& k& \7 F5 m. h: Hthe 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
* z1 `' e. R2 zremain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
+ i* r/ l5 t; T* p  l) Hto persist over 2009 to 2011. We anticipate that nationwide
3 [# {! x% k  w* H) ~residential construction will fall further to around
  [, N0 h: |6 {0 n. H* J" b/ X125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
To quantify the degree of overpricing and overbuilding,
8 x: x# u- V1 d8 Awe first develop an empirical model, based on long-run
" r- w' H5 @  a! ~4 Lfundamentals 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& s1 @* d, p8 }  ^% j! Llong-run. Since homebuilders build to meet demand, we
regard housing prices and household formation as the drivers
; C+ L  R# Y4 f: gof residential construction.
1 i1 W6 I7 Q* K/ YTo 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
units were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
3 W: w% i9 ?- g$ a  P1 FRegionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
4 K( Z/ r* E' o9 o6 Y9 j) wpopulation inflows. Saskatoon, Calgary and Edmonton are
" t5 ?' _8 v1 O, _4 o; calready witnessing surges in their unsold new homes at the
% m5 [8 N1 O$ b, vvery time that the resale market has swung into strong
" {& ~, H4 A8 [/ H/ Gbuyers’ territory. Homebuilding in the Atlantic provinces
  I1 k, K2 x! e8 Hhas been relatively balanced but, while not plagued by structural
weakness, will be singed by the downturn nonetheless.
1 z1 I) Q) r; V. ?+ _Québec shows signs of strain – especially given the
: T+ `4 m* }  ^/ I: B% L+ bstrange accumulation of unabsorbed multiples on l’Île de
( u  F8 Q5 V# N, MMontréal – but recent building has been relatively balanced,
given the province’s history of under-building and low ownership
: Y& k, ?0 s# i6 Orates. While Ontario homebuilding will reel from a
* b) q1 I: ]( W" @' b& p* L3 {1 x) ocyclical downturn, the degree of structural weakness appears
+ B* b: e, {# I. flimited – with the important exception of the Toronto
5 \/ f! C- B# ~: ncondo market. Both in Toronto and Vancouver, historically
! s& ?; A7 }/ j( z+ l7 k$ K8 X) H/ Ehigh levels of apartment-style units presently under
construction mean that record numbers of condos will
- X5 r6 B; U* ?7 w- P/ j- Z9 ?reach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
, Z' E1 G  n% V: w, D5 v; O3 _spike severely – particularly in Vancouver. However, while
residential construction in B.C. will definitely droop, we
/ L! S4 h# t9 ?8 i  ]7 eanticipate that the West Coast will continue to benefit from
inter-provincial and international migration over the coming
years, 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
# r9 `2 P) G8 V1 qPascal Gauthier, Economist
# S. J% T1 H) E  ?; Y$ n( Z416-944-5730
& d! n" X8 X! S3 E4 ~) f# N  a
http://www.td.com/economics/special/gb0409_housing_exec.pdf

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