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
' Y7 m, H; N- K  l# n* K: gunsustainable levels of building. Our view is that house
$ H& {5 b9 b$ U) mprices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
2 Q' G! E8 b1 {) zoverpricing compelled a level of residential construction
1 t0 Q1 Y9 n2 B) r  k/ n9 ~* @that exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
three years.
By “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
both a cyclical downturn and a return of house prices
; c7 P* B0 {: {( Y+ t% ^0 i7 Pto fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
' w% L" ]$ i: A8 [where builders accumulate excessive inventories. Although
+ W* h, W( k) }! Bthere is evidence of both types, we contend that Canada’s
1 K) @* Z- g! d$ j: K8 y( R6 Q“overbuilding” was mainly of the first type, where
/ X( Y) w$ D: v+ _7 @8 u8 @homebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
4 R8 z. C2 |( |/ P# Q# U: y' D% Ithe 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
, l9 n4 i) }- N) o5 f- d. Sremain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
$ T$ u4 T6 T/ i2 |9 d  |is now undershooting fundamentals and we expect this
& ~: Q% z- c6 @  h7 ^& ]( Hto persist over 2009 to 2011. We anticipate that nationwide
( M% f; P: V$ o5 ?6 w5 z3 Y0 mresidential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
5 q! C, C6 k& \+ \7 A% t" Tin the fourth quarter.
9 N3 c& p/ b1 v3 U0 r/ @* V+ f; ?To quantify the degree of overpricing and overbuilding,
  d5 Y9 t4 R- n, c( f8 rwe first develop an empirical model, based on long-run
, r6 u, W0 b8 o( R+ ufundamentals 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
& n/ B, u. Q4 s. E) H# I, g' }regard housing prices and household formation as the drivers
of residential construction.
5 ?3 L* J7 m  c- C, k  nTo examine the degree of overbuilding, we employ a
" L  {7 Q1 f& p4 l4 w8 m' |8 F“counter-factual,” asking what level of residential construction
( }6 j; t* |9 f  M/ Hwould have occurred if housing had been priced
* Y# Y. h* C. A4 g! P( h2 N) hoptimally. We find that actual homebuilding exceeded this
, g( q) ?* y- d6 q! h/ ifundamental-justified level by about 12%. Although new
/ o6 m8 L  [" v3 |! U/ [/ {5 Zunits were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
+ m& ]) F# J# ~- z6 G/ zRegionally, we see the greatest strains on the Prairies,
: J0 l) w; ]+ x' Mwhere housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
very time that the resale market has swung into strong
buyers’ territory. Homebuilding in the Atlantic provinces
3 @0 n/ |! S, w# e% o" S  v% `has been relatively balanced but, while not plagued by structural
/ C& L# G- ]/ @9 O  `: D  yweakness, will be singed by the downturn nonetheless.
, [1 i4 f* k3 J  ^* c. x. `+ MQuébec shows signs of strain – especially given the
" R; l, T% H. [  istrange accumulation of unabsorbed multiples on l’Île de
Montréal – but recent building has been relatively balanced,
( N, t4 ?( x. X6 hgiven the province’s history of under-building and low ownership
2 B( }4 x; c" z# c, t- E0 Erates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
# H: T4 a5 g% ~  J' vlimited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
3 C) a! S- U' s$ mhigh levels of apartment-style units presently under
construction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
- ]) Y6 O- O1 {) r5 [3 X% t# ?9 Ecyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
  _( D7 v9 I$ xresidential construction in B.C. will definitely droop, we
6 B+ h0 h7 D. X, o+ Tanticipate 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
7 u) w1 @7 e/ D1 ^& ]) QMARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
Pascal Gauthier, Economist
( i# a6 \7 P7 B- D416-944-5730
# P9 L$ @( O+ C, S0 I. R8 ]
3 J& o1 I4 P) ]  ^1 [5 K8 ~http://www.td.com/economics/special/gb0409_housing_exec.pdf

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