TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
6 N' }7 f9 w  ~from 2002 to 2008, unsustainable price increases drove
unsustainable levels of building. Our view is that house
( a* w# l# G3 }: X% cprices exceeded the value of housing that was justified by
+ R+ v/ |0 i  \; @+ W" `fundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
7 A# n( V' q: F) x! |that exceeded its fundamental-justified level by approximately
$ T. y, c) q# X/ Q) k4 r12%, an excess that was exaggerated in the past
1 @) I5 _: t+ jthree years.
3 }7 K/ m$ z; l; YBy “overpricing” we mean that prices detached from
  x7 p& t# r# [$ Q  Etheir fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
2 h3 ?, q2 @9 m' t6 ?- bboth a cyclical downturn and a return of house prices
to fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
7 t6 c( k) M  h# owhere homebuyers buy up too many houses and
" e) y; ?4 l4 H' _2 f" Rthat this demand cannot be sustained; and “supply-driven”
9 t, ~$ H! g4 W7 R0 \3 O% r: d! Iwhere builders accumulate excessive inventories. Although
" M. L( }2 f: _  X. \& Vthere is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
" n, H! h5 j; R- K. B! R3 Ghomebuyers pushed homebuilding to an unsustainable pitch
5 U2 a$ s( {. s( d* a5 Gthat is now being rapidly reined in.
While 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
. o* `# {# ]2 f+ A3 B6 bfrom the cyclical downturn, house price growth will
remain choppy and new residential construction will be
6 w) M+ u5 L* T" O3 f* R+ E0 Sdampened, 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
: E4 ?, ^" i6 w; N# I125,000 starts over 2009 with a trough around 115,000 units
% |1 n* B7 E+ r7 q" yin the fourth quarter.
To 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
0 E7 }! Q: J, x% t1 rprovince. Affordability is the key concept behind home
+ V: t7 \; G+ Jvalues since house prices should track incomes over the
6 |- Q3 l4 d  H$ {long-run. Since homebuilders build to meet demand, we
regard housing prices and household formation as the drivers
% S" H+ ^2 B- C. k" G' _0 u2 vof residential construction.
) {" w! u7 q5 ?2 B# O& X" {To examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
" B, Y' X6 h  N5 @5 r5 t: I( Moptimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
6 w# s; l8 L4 i1 f1 h, Z! E1 W+ R" junits were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
+ Y9 ^& i# n$ e% F6 O# |Regionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
0 L" L" ?0 D3 |6 v6 `0 Y6 b3 l$ Kpopulation inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
& u, D; i% }) G$ Hvery time that the resale market has swung into strong
6 u4 G7 e. W: tbuyers’ territory. Homebuilding in the Atlantic provinces
6 ~+ r. I( i9 H1 X* Lhas 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
, P. D4 J9 h- P- nstrange accumulation of unabsorbed multiples on l’Île de
Montréal – but recent building has been relatively balanced,
( y/ j) k* p0 x; ngiven 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
' H1 H" O0 l' X6 n$ Nlimited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
5 ~6 t# @# x. n$ G. G7 y) rhigh levels of apartment-style units presently under
% H" W; Z9 S+ Q  D* O/ s: oconstruction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
7 P& }# v: c# D# b$ l) ?2 a0 zcyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
residential construction in B.C. will definitely droop, we
6 p8 s5 h6 G9 L" Q& Nanticipate 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
2 Z3 I+ f- D$ J+ j& P. I5 }MARKET RETURNS TO FUNDAMENTALS
4 D- y; @8 U% YGrant Bishop, Economist
& j' h/ g0 q& V# I& o% ?$ a8 a- ~416-982-8063
Pascal Gauthier, Economist
2 A, v+ B# v2 P3 B7 G- g( j0 U416-944-5730

( d; ?" E$ Q0 A( h6 Y4 }6 E5 D) \' P: dhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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