TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
+ @2 t' X* E: U5 ?6 f/ j4 Rfrom 2002 to 2008, unsustainable price increases drove
8 Z7 V. L0 D6 \- h6 R# m3 J( {unsustainable levels of building. Our view is that house
prices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
- T, T7 U; e% n; Gthat exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
three years.
* L* K! w: h* H+ a: ?8 N+ uBy “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
' G' Y* P) Z! \/ \" M" \. l5 gboth a cyclical downturn and a return of house prices
, o% w. M( |4 G! F3 [8 ?to fundamentally justified levels.
7 ~( I! g8 \7 s5 O. @2 n$ ^8 jWe consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
1 r% Y8 R! A& r+ Rwhere builders accumulate excessive inventories. Although
8 t; l: [: K& A, Y- q" d0 ythere 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
that is now being rapidly reined in.
* s+ i. Y( R8 U: hWhile most markets won’t face U.S.-style overhangs,
0 J5 E; [# n# x2 F3 c1 y, Tthe construction of too many new homes over the boom
means a deepened slump. This overbuilding will likely weigh
" [/ g' g) ^) M2 a3 von markets over the next few years. Even as Canada recovers
from the cyclical downturn, house price growth will
remain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
. m( `( i$ F, F: R  Bis now undershooting fundamentals and we expect this
4 H8 t, N% k  mto persist over 2009 to 2011. We anticipate that nationwide
residential construction will fall further to around
& F  X- N: \# T125,000 starts over 2009 with a trough around 115,000 units
+ L1 C$ z- n  L- z7 }, Win the fourth quarter.
; g8 ~# B1 Z8 C+ S+ G& eTo quantify the degree of overpricing and overbuilding,
we first develop an empirical model, based on long-run
4 E( x2 w1 ~4 @( {. @5 s$ wfundamentals of house prices and housing starts in each
province. Affordability is the key concept behind home
% L7 _2 ~7 M8 b9 R- Hvalues since house prices should track incomes over the
long-run. Since homebuilders build to meet demand, we
" H' e' ]$ T# H+ X! Lregard housing prices and household formation as the drivers
of residential construction.
; P8 n& b3 F1 D. [4 q1 L+ |& `: L( xTo examine the degree of overbuilding, we employ a
, F* k3 b4 f5 Q' V5 U* _“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
1 c0 m5 [, k, |3 X  Y* Nunits were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
7 y' S# h9 t! v# E+ R( hwhere housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
: `% B+ L% h+ falready 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
! u5 J: s$ W( W: D# thas been relatively balanced but, while not plagued by structural
  M0 U, |. d' ?% e7 sweakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
$ y6 i  U6 |" K8 L: B7 t" z. Q1 ^strange 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
; X3 q4 @2 U; }" u2 K: t5 n- F! e2 j, Erates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
& L( Y8 ~" g3 P; m, s9 A3 U. Hlimited – with the important exception of the Toronto
" W# q: O+ }& b2 S3 Kcondo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
( `# L3 x& f+ u( }construction 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
anticipate that the West Coast will continue to benefit from
inter-provincial and international migration over the coming
5 p5 p# S5 b4 Ryears, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
3 ^+ K) c7 |6 A" d0 Q  Q( F3 ?: AOVERPRICED AND OVERBUILT: CANADIAN HOUSING
9 J/ D  z6 \, F3 ~: _% |$ |' x5 NMARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
* U4 P: R8 h& |( jPascal Gauthier, Economist
416-944-5730
6 z( q9 {$ C( J
( }% H9 r# W! ?1 I5 Ohttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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