TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
# ?* Q$ E; m3 q0 s" ?0 kfrom 2002 to 2008, unsustainable price increases drove
: v) K$ P, G- a5 z0 c1 `! [& aunsustainable levels of building. Our view is that house
' B0 u; g/ L* H; v, n- Fprices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
  G9 K" }: X( noverpricing compelled a level of residential construction
' _- `' z! B8 B) @that exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
# t% D) P6 X; ?9 I) [: E2 Zthree years.
By “overpricing” we mean that prices detached from
; B% T9 P0 @+ o9 l% Itheir fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
  B9 r1 C4 K/ {both a cyclical downturn and a return of house prices
% T9 X: X4 z6 U; J) Tto fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
% Q# O1 A; ?3 Q; ]where homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
0 R3 [5 w; Q& N6 @0 j: l7 ?where builders accumulate excessive inventories. Although
" h9 \' j1 r# F8 P0 fthere is evidence of both types, we contend that Canada’s
" W1 ^7 G, W8 p3 G3 _& d& j7 |“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
7 n/ ]% z6 V9 V* v+ Kthe construction of too many new homes over the boom
means a deepened slump. This overbuilding will likely weigh
( u5 p3 n8 q# p1 ?/ Lon markets over the next few years. Even as Canada recovers
, C, y5 ~; d. \% Z- d9 ~" e: _- Afrom the cyclical downturn, house price growth will
remain choppy and new residential construction will be
- O7 b( u  F4 \: d* D" e. P: tdampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
' p  u$ s, Y" cto persist over 2009 to 2011. We anticipate that nationwide
6 s2 X1 P9 k; z* l) Q0 N3 Aresidential construction will fall further to around
/ F$ x9 v! s* j: u! ?5 f2 b125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
) Y3 a4 t- _% G. xTo 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
# |  ~: d  `4 B' I7 Wprovince. 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
2 ?6 a+ M$ @2 W) N" Hregard housing prices and household formation as the drivers
% S+ J1 X0 z+ _8 I0 x4 d5 Sof residential construction.
To examine the degree of overbuilding, we employ a
' L. B: s( r* k* e+ d, B“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
" z$ a  ]" [# n6 H, L5 e' [fundamental-justified level by about 12%. Although new
5 }9 T( ^; H+ tunits were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
6 g9 v9 ]5 `1 Q# \1 u* Owhere housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
% [8 Z1 z  Q# K+ t! Balready witnessing surges in their unsold new homes at the
- z8 \! ?. y" ^7 tvery time that the resale market has swung into strong
* I8 a7 ]# Z" Bbuyers’ territory. Homebuilding in the Atlantic provinces
; {' F% C/ }2 p0 h1 x- e5 y! S0 ehas 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
4 n* H* s4 P( B$ F! Y8 |2 _, o8 AMontréal – but recent building has been relatively balanced,
9 R; b8 t6 T$ G% Tgiven the province’s history of under-building and low ownership
$ N( g2 S; S: c; z$ J7 J) ^) Krates. While Ontario homebuilding will reel from a
' e% u, i9 b8 _cyclical downturn, the degree of structural weakness appears
- a- a/ f* h) Q8 D; I! b5 c# nlimited – with the important exception of the Toronto
" L2 s! U& Z2 J! S: m0 Xcondo market. Both in Toronto and Vancouver, historically
& y2 Y) c5 C! d- r' yhigh levels of apartment-style units presently under
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
) J  @  V  i6 G: Q8 G  v) vresidential construction in B.C. will definitely droop, we
2 T5 T+ ?' P5 s% N* `3 e" `anticipate that the West Coast will continue to benefit from
7 S0 H  i% Y* j- z! Ainter-provincial and international migration over the coming
' R- j! D3 Q' Z: |2 H! M. ryears, which, along with improvements in affordability,
/ ]8 H4 z& j5 Q, w. O6 Zwill alleviate some of the pressure from overbuilding.
/ H( W0 A' W( TOVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
Pascal Gauthier, Economist
416-944-5730

5 N; y  w3 N) T! J% Ghttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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