TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
- m! T0 y; ]' Q8 ufrom 2002 to 2008, unsustainable price increases drove
unsustainable levels of building. Our view is that house
, X- ?9 Y; x+ R+ B  l1 fprices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
- G' c  b2 _" Y" moverpricing compelled a level of residential construction
. i/ w; m8 o7 Cthat exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
three years.
0 ]* e  g6 u3 o: a% KBy “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
both a cyclical downturn and a return of house prices
9 |4 ^3 D$ c) U$ v% zto fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
! ?; h5 `- ]. u0 ?" fwhere homebuyers buy up too many houses and
! N: H1 J9 F: Y) l7 ]+ ethat this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
3 J8 R# h5 k. V2 }* V6 o/ Rthere is evidence of both types, we contend that Canada’s
2 F) `4 u4 N4 p9 {: f+ b* n“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
+ ?+ B- t+ a4 F9 \. `8 @; xthat is now being rapidly reined in.
" e7 J, r* _: U  n: Q& MWhile most markets won’t face U.S.-style overhangs,
3 k& I2 a4 X" M* w, F0 zthe construction of too many new homes over the boom
means a deepened slump. This overbuilding will likely weigh
$ i  u5 e) J* a1 n( ?' u, won markets over the next few years. Even as Canada recovers
from the cyclical downturn, house price growth will
5 t: _6 t6 J: X0 ]& i, f7 Mremain choppy and new residential construction will be
0 H. f+ y- p9 {$ E5 i1 z! \2 Wdampened, owing to this structural weakness. Construction
  ?0 y4 r6 Y) ?/ eis now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
residential construction will fall further to around
+ z( s+ |1 L% K6 V( I$ z3 V125,000 starts over 2009 with a trough around 115,000 units
8 D( Z% f7 H: z+ B$ L9 I4 m; Nin the fourth quarter.
To quantify the degree of overpricing and overbuilding,
% U, x2 f1 f& Y' cwe first develop an empirical model, based on long-run
( O# G0 f3 z/ y. H  U( B( mfundamentals 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
( v; K$ @* {* M; h& ~& \8 i. A' m/ mlong-run. Since homebuilders build to meet demand, we
5 Y& w! L0 o! m7 a- o( q& a; N% yregard housing prices and household formation as the drivers
of residential construction.
To examine the degree of overbuilding, we employ a
9 Y) V$ u/ d7 Y+ g% d& Y! y“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
2 R/ a* L4 o8 aoptimally. We find that actual homebuilding exceeded this
; M) w8 H5 s1 B1 \! ifundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
  Q4 N: ?" d; x0 w( S4 B* j  amany houses at prices that exceeded fundamentals.
* I  S* C" H& ]Regionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
0 J  J3 n" Q& X, m5 zpopulation inflows. Saskatoon, Calgary and Edmonton are
2 x5 S' P% m/ U5 R/ E/ _already witnessing surges in their unsold new homes at the
very time that the resale market has swung into strong
9 |) O( @* p) o& l& M  Zbuyers’ territory. Homebuilding in the Atlantic provinces
has 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
% c5 I0 n0 T1 U' `$ _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
( h: m3 @3 V4 i% P% ~rates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
; t* V0 Z; o6 E' Mhigh levels of apartment-style units presently under
construction mean that record numbers of condos will
7 |; ?3 V; [2 H8 I2 Q7 M4 _. {reach completion during 2009. If absorption rates fall, as
$ F2 h% h0 l2 X( xcyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
residential construction in B.C. will definitely droop, we
3 \5 z* [7 B: o( }anticipate that the West Coast will continue to benefit from
; z/ C/ W: c1 |- f' v+ rinter-provincial and international migration over the coming
# {7 [: o  k" \years, which, along with improvements in affordability,
& `5 z0 p9 ]% G* dwill alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
2 ^+ f: a3 O3 k$ I3 RMARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
+ h5 k6 K( k8 H7 E1 \# Z5 B; y9 q416-982-8063
Pascal Gauthier, Economist
416-944-5730

; @  e7 B% E- Ahttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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