TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
- d7 `1 e- l( f. `( }! kfrom 2002 to 2008, unsustainable price increases drove
) h4 F- Z4 w. m' I) \unsustainable levels of building. Our view is that house
+ T' I+ V# ?  s' A7 o. P  Jprices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
" _8 `) g* ^9 f+ c2 b7 Q* k5 ~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
6 l) n( a0 b, J$ T- P4 z, {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”
where builders accumulate excessive inventories. Although
- I, X- Q! v- L  R$ \3 kthere is evidence of both types, we contend that Canada’s
3 x# k; {& L; |# N“overbuilding” was mainly of the first type, where
" v5 }) {5 p; V  ]homebuyers pushed homebuilding to an unsustainable pitch
" Y. f4 k8 U6 G5 Y4 H  b' [that is now being rapidly reined in.
) n' u/ L: x( y6 |) o8 xWhile most markets won’t face U.S.-style overhangs,
the construction of too many new homes over the boom
) j( O& o& i5 Umeans a deepened slump. This overbuilding will likely weigh
/ d: u/ y# ?, o7 D/ w: c" lon markets over the next few years. Even as Canada recovers
" c& j& f4 o# T- m/ K) o! F# ^from the cyclical downturn, house price growth will
6 J' I/ B' ^8 w/ y) y/ r; }& U: a0 Zremain choppy and new residential construction will be
0 @* D" C  Z1 ^3 Z% _! l0 odampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
3 {/ c# z; P' y) Y) Cto 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
' H6 _$ |- i! o$ a0 D. V/ L  cin the fourth quarter.
! I& T% J8 ^1 j4 YTo 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
8 b$ M2 I# t5 u6 ~0 B2 vprovince. 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
% y' H& d' [3 \) Dregard housing prices and household formation as the drivers
: ~5 P, V+ ?5 ^; l4 L3 q' G+ m1 w, Gof residential construction.
6 t" M6 H1 C* k, C; y, HTo examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
  d" p; U* b( K! h+ iwould have occurred if housing had been priced
( ^) q/ I: S) j5 V/ `optimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
: x* n) D. z0 g* B; d1 punits were being absorbed, homebuyers simply bought too
) c0 T8 S& l/ Q9 qmany houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
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 w1 ?+ f% n. bvery time that the resale market has swung into strong
0 F3 M7 t+ R5 Pbuyers’ territory. Homebuilding in the Atlantic provinces
& |9 j( p7 E, l& P; I1 lhas been relatively balanced but, while not plagued by structural
4 t# |  I; O4 ^8 Z- Y# a8 `weakness, will be singed by the downturn nonetheless.
1 I' d2 I' j9 t( F6 E: U: W4 EQuébec shows signs of strain – especially given the
, {  y1 N/ E5 W* a  b+ Lstrange 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
limited – with the important exception of the Toronto
/ z% k; b1 z9 r7 \% }$ pcondo market. Both in Toronto and Vancouver, historically
6 x7 x9 ?1 Q/ t! O" |! I4 I' nhigh levels of apartment-style units presently under
0 E7 V/ n6 Q. Xconstruction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
( x; t% X  X6 Dcyclical 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
inter-provincial and international migration over the coming
years, which, along with improvements in affordability,
9 P7 f, ?8 B* s- [& U' |  {/ ~( Vwill alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
% C+ J) a% y- D% o- D. WMARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
7 z. l6 N! Q4 c* K* k416-982-8063
Pascal Gauthier, Economist
416-944-5730

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

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