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
( ~1 A& x$ c2 d* D" G& E6 {. T$ Nprices 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
/ z3 N0 q5 w1 g$ i6 o12%, an excess that was exaggerated in the past
three years.
  S$ Q( o. d8 u+ I1 UBy “overpricing” we mean that prices detached from
( S- q8 ^- i' T8 btheir fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
& W  I& X6 ^9 M6 @% [  `! f" w: pboth a cyclical downturn and a return of house prices
  h, s) h! U7 U8 V) l: d0 l+ g2 yto fundamentally justified levels.
9 L1 `) O5 u  v% d& f1 H  E" fWe consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
4 q/ |9 ^3 ]0 C+ }3 Hthat this demand cannot be sustained; and “supply-driven”
6 X( x& l# A* l' jwhere builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
) c* f# _$ w. x& P2 Yhomebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
/ B/ U6 a0 z6 Kthe construction of too many new homes over the boom
1 r( _# U5 o2 omeans a deepened slump. This overbuilding will likely weigh
7 g: _& z* N  u  t9 D# Hon markets over the next few years. Even as Canada recovers
, Q$ J4 J1 K' H) U7 ~# [0 Z  xfrom the cyclical downturn, house price growth will
$ Q7 S6 G8 W! R9 Premain choppy and new residential construction will be
dampened, 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
% M0 ?. w* u/ M125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
To quantify the degree of overpricing and overbuilding,
( g4 g  v, Y; J2 c% \& xwe 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
) i3 m3 x, i9 Q1 g2 [9 o2 v) t/ [regard housing prices and household formation as the drivers
of residential construction.
To examine the degree of overbuilding, we employ a
6 [( W3 K5 A. Y+ Z6 F“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
5 s/ ]1 V7 R( M/ m) u6 Z* `* Efundamental-justified level by about 12%. Although new
5 M0 \& f# e% @6 U* ]1 uunits were being absorbed, homebuyers simply bought too
. F/ Z6 L) O" y9 w) [2 Y% }0 G; ymany houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
; k* `, r" @/ p- u* j! H6 [4 |where housing demand will further contract under waning
+ b2 c" y! M7 b- c, Zpopulation inflows. Saskatoon, Calgary and Edmonton are
$ \7 Z) a( G  U3 G1 P+ Jalready witnessing surges in their unsold new homes at the
6 r& s1 i  C1 l. p! zvery time that the resale market has swung into strong
buyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
0 n# N4 |, x$ m( ~weakness, will be singed by the downturn nonetheless.
) u8 }1 R6 e6 C# v% gQuébec shows signs of strain – especially given the
strange accumulation of unabsorbed multiples on l’Île de
Montréal – but recent building has been relatively balanced,
: {" V" A7 g; K8 \given the province’s history of under-building and low ownership
, \- V) A) z$ H% Yrates. While Ontario homebuilding will reel from a
5 d: F* I! t0 ]( g: Ccyclical downturn, the degree of structural weakness appears
% `- V5 X* t7 N; p9 p  dlimited – with the important exception of the Toronto
; ], e3 w- N/ v" q3 \: M0 ~' wcondo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
construction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
8 g( E" S, q/ d% ?$ [0 A# L  Yresidential construction in B.C. will definitely droop, we
anticipate that the West Coast will continue to benefit from
# w" g7 _( n" Ainter-provincial and international migration over the coming
years, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
* K; E  ^2 B! LOVERPRICED AND OVERBUILT: CANADIAN HOUSING
/ T6 d) }0 q6 M% |# m$ EMARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
) p) I! I, z2 uPascal Gauthier, Economist
416-944-5730
* r! n  y- {# b* V4 r
http://www.td.com/economics/special/gb0409_housing_exec.pdf

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