TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
9 _) i) D3 Z5 d1 afrom 2002 to 2008, unsustainable price increases drove
unsustainable levels of building. Our view is that house
prices exceeded the value of housing that was justified by
9 m( j, f6 m, z; Yfundamentals by approximately 9% nationwide. This
: e: M: G- v' g4 B# `4 _overpricing compelled a level of residential construction
& P6 b; [. @8 A+ N1 a0 g1 O, i  k$ _that exceeded its fundamental-justified level by approximately
5 z7 j) j6 m5 ^+ b12%, an excess that was exaggerated in the past
! v6 r3 Y* c. O# |7 Rthree years.
By “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
" w- G$ C+ y$ Q! g7 ~+ Naffordability. The current unwinding of house prices reflects
6 [/ V* M: `. [) Kboth 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
& n; H1 j5 \, X# k7 Kthat this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
  P3 J! z8 j! ^% U+ [) g5 ~3 Nhomebuyers pushed homebuilding to an unsustainable pitch
0 T1 k5 t6 d: E8 e; K* P) _9 _2 tthat is now being rapidly reined in.
# t& o- Q* `9 ~5 k$ Q" L: i* ~While most markets won’t face U.S.-style overhangs,
: q  c& D( Y; ^& mthe construction of too many new homes over the boom
means a deepened slump. This overbuilding will likely weigh
# h& t8 Y9 M4 o8 o; t/ Fon markets over the next few years. Even as Canada recovers
from the cyclical downturn, house price growth will
: G" ~" x! R( w5 O& Hremain choppy and new residential construction will be
& l8 [) B: a! S3 g7 K* u  N, Hdampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
" T( p# n: `  V* A# A! f/ }9 Lresidential construction will fall further to around
5 ?0 x- z; A. G$ u; _125,000 starts over 2009 with a trough around 115,000 units
; J/ A( W. a/ \8 ?, Win the fourth quarter.
To quantify the degree of overpricing and overbuilding,
. \7 u9 q' O) g$ R( R8 pwe first develop an empirical model, based on long-run
4 Q: u3 f5 @5 V0 Mfundamentals of house prices and housing starts in each
province. Affordability is the key concept behind home
2 O6 W2 A" ]2 q, W9 O8 p( `values since house prices should track incomes over the
long-run. Since homebuilders build to meet demand, we
regard housing prices and household formation as the drivers
+ c) ^) R3 b9 w% V6 M% K6 bof residential construction.
To examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
! w  y6 B! _  e1 C0 \would have occurred if housing had been priced
7 H9 U0 r0 I4 Zoptimally. We find that actual homebuilding exceeded this
% A# W  w8 }8 f2 A' ]fundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
2 j! }4 e1 Y5 {many houses at prices that exceeded fundamentals.
" n3 u9 _3 }6 k' N. `$ u/ mRegionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
9 H8 ?+ [3 `* C! M& ^4 s: J/ y, Mpopulation inflows. Saskatoon, Calgary and Edmonton are
" f/ _3 s+ g6 ?2 d: {0 A' `8 ralready witnessing surges in their unsold new homes at the
" [0 H0 k7 A) |9 M$ u% svery time that the resale market has swung into strong
buyers’ 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
strange accumulation of unabsorbed multiples on l’Île de
) l' g# |- [1 NMontréal – but recent building has been relatively balanced,
3 {# H6 g2 H, K8 d% S+ egiven the province’s history of under-building and low ownership
+ |) h6 K$ O8 N7 n& qrates. While Ontario homebuilding will reel from a
% V1 g- X6 q+ J2 tcyclical downturn, the degree of structural weakness appears
+ k9 E7 b, D4 D  u" rlimited – with the important exception of the Toronto
2 E. l% o; t+ P; Mcondo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
construction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
" F3 J. s1 a- o* R" Ocyclical factors would indicate, condo inventories could
3 t* m7 r+ V$ l& P# i& Q1 Wspike 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
' J7 t9 S3 r8 E  \4 ^" K+ e$ |years, which, along with improvements in affordability,
  F, g+ n: G5 {1 _# i1 t, nwill alleviate some of the pressure from overbuilding.
# \  D" l& H8 u8 {8 p, J+ tOVERPRICED AND OVERBUILT: CANADIAN HOUSING
( f2 i$ u8 `1 l' k0 {MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
& j* a4 p) d+ _( }, o$ W1 M" b, k416-982-8063
  t& L# m% |1 |$ J, ]Pascal Gauthier, Economist
3 Q- ~; P# E1 {! z! c/ Y! ?: ~416-944-5730

) f; Y- c( {3 p. t; u/ Y6 H7 f; ehttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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