TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
- t' i: x7 |) r5 t* P$ [9 |6 Vfrom 2002 to 2008, unsustainable price increases drove
unsustainable levels of building. Our view is that house
6 ?5 R! s# a+ m# [1 [$ Sprices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
) D! W# `8 ~9 Z; z2 c, Roverpricing compelled a level of residential construction
# H" W& u' N$ |8 Xthat exceeded its fundamental-justified level by approximately
* n* ^$ T5 S: \12%, an excess that was exaggerated in the past
three years.
( F* A7 P' O2 e4 r; r1 vBy “overpricing” we mean that prices detached from
8 o- \% t/ F; A  Stheir fundamentals, as witnessed by a steep erosion of
! [( V9 {& _9 z1 waffordability. The current unwinding of house prices reflects
both a cyclical downturn and a return of house prices
to 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”
* r" ?4 X8 O  C$ k- kwhere builders accumulate excessive inventories. Although
" Q0 G! Y  [+ ~' [; uthere is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
2 R2 f! }, p. `3 r8 n) Rthat is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
( f% a7 \- v, M! w5 bthe construction of too many new homes over the boom
1 T, @9 i2 D# l5 A: N- c# z, Kmeans a deepened slump. This overbuilding will likely weigh
on markets over the next few years. Even as Canada recovers
# \- K: S/ e- Z2 sfrom the cyclical downturn, house price growth will
remain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
  C: b1 C. d( a2 kis now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
, N- b2 a0 q: ^residential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
: g! A4 e4 H( V; fTo quantify the degree of overpricing and overbuilding,
we 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
% x: ]5 v, V2 O! i8 [% o, ]1 Hlong-run. Since homebuilders build to meet demand, we
regard housing prices and household formation as the drivers
& {) v* z+ h1 ]/ jof residential construction.
9 X( ~( s) L% n, ~. X! Y6 b9 DTo examine the degree of overbuilding, we employ a
# c  A3 I; `0 f7 Y“counter-factual,” asking what level of residential construction
" C0 q9 s+ ~, ?( O- D$ lwould have occurred if housing had been priced
3 e" O0 C8 o! ~+ y! n) `optimally. We find that actual homebuilding exceeded this
0 o, Y' z% H% V+ b) T* J7 ]) b* Sfundamental-justified level by about 12%. Although new
' k( W3 f( @) m; m" U, i- Xunits were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
: g8 a. y8 [: Q$ U7 tRegionally, we see the greatest strains on the Prairies,
. Z3 n" a2 [% a1 n! h2 ]where housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
% [0 M% L: O" w6 `very time that the resale market has swung into strong
buyers’ territory. Homebuilding in the Atlantic provinces
  P7 r. L' x; F) \6 ^4 g) Jhas 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
strange accumulation of unabsorbed multiples on l’Île de
5 Q9 q9 ?9 V4 n% Z- `Montréal – but recent building has been relatively balanced,
: M% c1 L9 h0 X" ugiven the province’s history of under-building and low ownership
# G3 {0 |) {, o' R# Y: lrates. While Ontario homebuilding will reel from a
$ N- z* }5 F! }* s" Jcyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
6 T. n: N8 {. I+ ]condo market. Both in Toronto and Vancouver, historically
9 d) k- Z5 H" G0 B' C9 w- T0 jhigh levels of apartment-style units presently under
* H  o6 \& x( E" p" ^8 yconstruction 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
residential construction in B.C. will definitely droop, we
- w: }# x, [# p+ n, l4 Q- J& fanticipate that the West Coast will continue to benefit from
' \: U9 O7 \% {: Winter-provincial and international migration over the coming
# K1 w/ {& b( n0 B4 u& Oyears, which, along with improvements in affordability,
0 `! `2 L+ `- D1 G. H9 Cwill alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
8 r! s; d  e9 r$ I6 G9 ?, ?MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
Pascal Gauthier, Economist
% ?! J/ y8 I0 [1 s0 _3 K7 E416-944-5730

) C% u$ }6 w7 [" B# Dhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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