TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
. j! H4 w( N( I- U/ Hfrom 2002 to 2008, unsustainable price increases drove
9 m& W, D2 s8 J* t5 Cunsustainable 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
, o1 O" n1 h' Q' wthat exceeded its fundamental-justified level by approximately
0 H3 H8 L* j! U12%, an excess that was exaggerated in the past
three years.
By “overpricing” we mean that prices detached from
: j4 g) K- Y, L7 z! Vtheir fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
, O, I  ~# E, g! qboth a cyclical downturn and a return of house prices
* T- Y- O7 \1 A2 C+ hto fundamentally justified levels.
0 Z6 b. T* b7 Y$ H7 iWe consider “overbuilding” of two forms: “demanddriven”
- k4 O& q! q2 A/ t/ I) x8 k: {where homebuyers buy up too many houses and
* N& a  l8 O" m# zthat 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
" W$ d* x+ S- q* K“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
0 d3 u' X9 N) _& B5 \; I! \that is now being rapidly reined in.
% v$ a7 i2 A1 v0 ?) z5 R) bWhile most markets won’t face U.S.-style overhangs,
the construction of too many new homes over the boom
/ @+ I7 u" I1 \! ymeans a deepened slump. This overbuilding will likely weigh
. a8 f$ ~2 q3 @5 B" x* Y/ |4 |, a7 Yon markets over the next few years. Even as Canada recovers
7 N, f& \5 h) }1 F- D4 gfrom the cyclical downturn, house price growth will
remain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
to 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
% r) \, O5 e! `& W2 M* F! gin the fourth quarter.
To quantify the degree of overpricing and overbuilding,
  s0 a/ E2 s8 {& f/ b: @/ Uwe first develop an empirical model, based on long-run
fundamentals of house prices and housing starts in each
province. Affordability is the key concept behind home
  `8 f! n* L' y& Q; rvalues since house prices should track incomes over the
, n" i3 }! H' F5 ?7 Along-run. Since homebuilders build to meet demand, we
regard housing prices and household formation as the drivers
of residential construction.
- W. H; p' _6 B& m, f: t* QTo examine the degree of overbuilding, we employ a
& {" o, n1 a7 m# W4 C1 y. M; m“counter-factual,” asking what level of residential construction
! r0 g2 W% r7 Z7 m: kwould have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
+ K# A2 I4 l; ]/ bfundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
$ [4 a  j( J& d0 emany houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
  q7 `2 D2 B; x9 d6 [! a7 G/ mwhere housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
$ P, ?. S' P4 H, z3 t% J' malready 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
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
; f' X2 d& W* ^  ~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
2 Q8 c! ^$ m* |6 `* @* mrates. While Ontario homebuilding will reel from a
) a4 P5 Q  j% F% p$ C# c' r/ bcyclical downturn, the degree of structural weakness appears
. t* z  G) {& Zlimited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
' t# X- W1 N2 M% D% |$ O: V! |construction mean that record numbers of condos will
; [4 U8 {. x) h1 o' Yreach completion during 2009. If absorption rates fall, as
  `" b3 \/ e- R  bcyclical 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
1 k$ V0 K. V* i* J: d  `* k+ s% s7 Xinter-provincial and international migration over the coming
( F" Y, \' b- ~6 p) Byears, which, along with improvements in affordability,
$ I) A- j1 W! cwill alleviate some of the pressure from overbuilding.
. \$ w6 h$ V/ c# o1 ^3 ?OVERPRICED AND OVERBUILT: CANADIAN HOUSING
* Y% v' T) c: rMARKET RETURNS TO FUNDAMENTALS
! f% G8 E6 K/ Q+ _Grant Bishop, Economist
: }- n3 O) ^7 B: |416-982-8063
: ?; k  Z6 w& O2 P3 @: l1 P! ?Pascal Gauthier, Economist
) E4 L$ a; C1 Y1 |# e( A416-944-5730

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

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