TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
7 a8 K2 c- t1 M" ]! y0 ]from 2002 to 2008, unsustainable price increases drove
/ R/ V2 a- K5 ?5 K5 H' Q; V0 x4 uunsustainable levels of building. Our view is that house
prices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
" X  Y; Y+ Z# l0 I& t& N. ]/ K% _) foverpricing compelled a level of residential construction
* v3 y& {8 L- z* I- R: q/ Rthat exceeded its fundamental-justified level by approximately
2 x$ I! O3 A/ J3 m12%, an excess that was exaggerated in the past
- X2 c& V! I5 x& H2 @$ E  R" B+ o2 q) Cthree years.
By “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
0 o% D, |" g; E  s6 xaffordability. The current unwinding of house prices reflects
/ i' ]+ f- u1 J. Lboth a cyclical downturn and a return of house prices
! j& u: c3 h( g: kto fundamentally justified levels.
- S! ~$ r6 o' G# DWe consider “overbuilding” of two forms: “demanddriven”
3 k. N. |; R' v7 ]' ^; y/ h$ E) J  {+ @where homebuyers buy up too many houses and
" ?+ O9 P( G0 X7 X( v, F  j& nthat this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
6 p; U% d+ x& lthere is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
% I6 m, H: H) C2 a" xhomebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
, c) r. B0 j/ X! i/ q$ o* D9 ethe construction of too many new homes over the boom
2 [7 g+ W+ F' \0 V& jmeans a deepened slump. This overbuilding will likely weigh
- b5 V9 X& D8 C/ g6 _& P1 Won markets over the next few years. Even as Canada recovers
from the cyclical downturn, house price growth will
  D' R2 H/ W+ |1 Sremain choppy and new residential construction will be
) ?! p' [. e9 a  y+ wdampened, owing to this structural weakness. Construction
  a6 U4 O% f. t- c  l- iis now undershooting fundamentals and we expect this
1 p: E# @" ]8 h- q+ r6 t9 ?to persist over 2009 to 2011. We anticipate that nationwide
residential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
To quantify the degree of overpricing and overbuilding,
  x9 x  k2 R  r+ }3 M8 Cwe first develop an empirical model, based on long-run
3 y5 ]+ b9 h, z9 Y$ S. \0 a: x4 pfundamentals of house prices and housing starts in each
" m- J/ F4 i0 V+ m7 R7 M$ R. o# s# Eprovince. 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
of residential construction.
To examine the degree of overbuilding, we employ a
! q, X8 @' I, c" |6 e“counter-factual,” asking what level of residential construction
- V& A5 ?! M; S' s$ vwould have occurred if housing had been priced
, Y+ K2 o  F, @/ F! _5 n2 P: H1 Aoptimally. We find that actual homebuilding exceeded this
: V1 u" D. P& s* O, n% d; \* Kfundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
9 D5 m" G- J# Q# C6 X1 c6 @9 W6 apopulation inflows. Saskatoon, Calgary and Edmonton are
+ d+ O) S2 M* ?! n5 Z- ?" f4 Balready witnessing surges in their unsold new homes at the
very time that the resale market has swung into strong
: b) C, @; G2 S6 j4 Y" Hbuyers’ territory. Homebuilding in the Atlantic provinces
5 Y: E$ Q. h% `1 l0 N3 [, w4 hhas been relatively balanced but, while not plagued by structural
weakness, will be singed by the downturn nonetheless.
, ?9 D8 Q: V& M. ^! ?4 WQuébec shows signs of strain – especially given the
strange accumulation of unabsorbed multiples on l’Île de
Montréal – but recent building has been relatively balanced,
given 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
' q7 B! A# o; e! Y. k6 ]limited – with the important exception of the Toronto
% e# {( ~  E4 l# m  gcondo market. Both in Toronto and Vancouver, historically
3 ^; d3 P" ^! H# R2 ^. T8 T2 Chigh levels of apartment-style units presently under
2 `. H' r/ x3 L% n  d% h7 C1 c& h* dconstruction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
4 r" v$ t0 C5 j0 }* ]8 icyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
residential construction in B.C. will definitely droop, we
anticipate that the West Coast will continue to benefit from
0 z0 `! K7 u2 s6 a" d5 F% {4 ninter-provincial and international migration over the coming
$ ?4 ?$ u& G4 ]4 V& `2 T* Hyears, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
, }! l/ x6 D% L& v) A% `OVERPRICED AND OVERBUILT: CANADIAN HOUSING
1 y- _# A* }5 w/ O4 X' AMARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
& n1 k% O5 d2 y+ b3 b# i% p0 q416-982-8063
Pascal Gauthier, Economist
( V# U) L6 D+ t' C$ C- G416-944-5730

http://www.td.com/economics/special/gb0409_housing_exec.pdf

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