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  d0 R9 v2 m3 m* xprices 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
three years.
3 m* P2 J% p( a8 Y0 @, w( DBy “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
) x  H" c. H  i! p0 lboth a cyclical downturn and a return of house prices
to fundamentally justified levels.
& Z7 a7 V6 o4 j6 e% U( Z! j6 G) d6 ]6 d$ _We consider “overbuilding” of two forms: “demanddriven”
+ ^' [& o6 a0 Zwhere homebuyers buy up too many houses and
7 B% k3 ?) U2 Tthat this demand cannot be sustained; and “supply-driven”
  K* |1 b. c+ a3 p) q( ywhere builders accumulate excessive inventories. Although
  [, t: B' T6 t) ~( _there is evidence of both types, we contend that Canada’s
) }7 c/ x  p/ g3 u7 L“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
* ~$ s5 j2 \4 G% H. sthat is now being rapidly reined in.
, u- T6 H( P* ?. L- cWhile most markets won’t face U.S.-style overhangs,
the 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
( ^/ D( U3 p; [from the cyclical downturn, house price growth will
remain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
( M$ S# T3 Q4 ?6 C4 P$ l$ ]  ^is now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
) R2 ^  Y3 P: W' jresidential construction will fall further to around
5 U6 W+ y" B2 c125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
% L0 x( y. X+ E& J, I9 ^To quantify the degree of overpricing and overbuilding,
- Z1 }) w+ r8 ?) ?6 l7 ~' ywe first develop an empirical model, based on long-run
& Q- z" [, }: G- T/ X) m0 ~. t. K! Tfundamentals 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
6 x1 t9 p. ^1 n. i( V3 {+ ~* b/ blong-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
  ^! d, H! c( K2 D: m: m“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
& I4 w9 Y/ i: k$ C* @* p0 Bunits were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
" r0 g8 i- e* M1 W! [$ sRegionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
7 s/ p: H, c8 Wpopulation inflows. Saskatoon, Calgary and Edmonton are
5 H7 [( I/ o/ n2 Xalready witnessing surges in their unsold new homes at the
very time that the resale market has swung into strong
' f; Y! f. H& lbuyers’ territory. Homebuilding in the Atlantic provinces
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
+ S0 c  Q3 o  N3 u9 O  I/ rstrange 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
! [/ E& g4 Z) b2 B4 T/ g, irates. While Ontario homebuilding will reel from a
8 j- U3 T7 |. a( w6 w& v2 `cyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
* _4 L2 u8 D# Y# _construction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
# w& ]* I" Y& f# Z2 s: o4 Pspike severely – particularly in Vancouver. However, while
4 r$ `) t& X) Cresidential construction in B.C. will definitely droop, we
anticipate that the West Coast will continue to benefit from
4 {. n9 ~* s' O( `, X: @  xinter-provincial and international migration over the coming
: D3 H& G6 |( }4 E% u+ T9 tyears, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
  i! x) B. _6 ?# b  r- EMARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
. G" F; h0 \7 [4 S9 S4 h416-982-8063
Pascal Gauthier, Economist
416-944-5730

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

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