TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
from 2002 to 2008, unsustainable price increases drove
unsustainable levels of building. Our view is that house
; J7 @4 D3 r( a" b& H, Gprices exceeded the value of housing that was justified by
2 Q0 {5 B7 ]2 mfundamentals by approximately 9% nationwide. This
+ ?1 F8 g7 ]: M6 u" _- ioverpricing compelled a level of residential construction
( L$ Y; i* u( \9 }$ {that exceeded its fundamental-justified level by approximately
' q6 K1 J/ G4 {! x8 Y12%, an excess that was exaggerated in the past
  i1 T: n- H" M+ Z  gthree years.
) }3 }. E: ~0 _By “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
; d3 f: }5 b' _( tboth a cyclical downturn and a return of house prices
4 s7 U; R9 O7 k0 _* Jto fundamentally justified levels.
, c5 N9 M2 F% n) HWe consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
2 f6 p* F0 D. J3 Q, ]that this demand cannot be sustained; and “supply-driven”
% c! z7 \+ s- K2 `6 t' Dwhere builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
  ^7 d5 A1 d% `6 C“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,
6 g0 E7 |7 T- |7 Z$ Y( @% Wthe construction of too many new homes over the boom
means a deepened slump. This overbuilding will likely weigh
on markets over the next few years. Even as Canada recovers
2 v, X6 E  e" O% s1 A9 x& xfrom the cyclical downturn, house price growth will
0 C9 \# d  ?" S7 w( X5 A4 P4 Yremain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
' l% z9 I- e8 W$ D& Fis now undershooting fundamentals and we expect this
+ r/ `4 h0 R; Eto 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
in the fourth quarter.
To quantify the degree of overpricing and overbuilding,
# C% P+ i" ~) x4 Y, pwe first develop an empirical model, based on long-run
) o6 n$ t4 U9 {- ?& s, n  f+ Zfundamentals of house prices and housing starts in each
" `! L7 p# r* y& W$ L$ T8 W0 Pprovince. Affordability is the key concept behind home
values since house prices should track incomes over the
4 T% f; H% q$ _/ J  R& Rlong-run. Since homebuilders build to meet demand, we
6 W1 o( i# _3 Z! {/ n2 \regard housing prices and household formation as the drivers
2 B) m( m% B& o" t7 s# hof residential construction.
" J5 ]8 Q8 E' M/ q; e* G+ FTo examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
: B) g8 f8 f& X: W5 g1 Xwould have occurred if housing had been priced
$ W: b3 h* M2 [( d7 Roptimally. We find that actual homebuilding exceeded this
( j  @9 [3 e0 q+ J1 o' Vfundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
. R& V- Q2 ?7 J/ eRegionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
very time that the resale market has swung into strong
; X& W  C3 W- Sbuyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
2 W% g" k7 L/ F/ i# e; Eweakness, will be singed by the downturn nonetheless.
1 H# G" v, d0 o% b  ~3 qQuébec shows signs of strain – especially given the
3 U8 v) k; m% o- _4 F+ `strange accumulation of unabsorbed multiples on l’Île de
" K$ N& e7 J6 }! a1 ]% k2 JMontréal – but recent building has been relatively balanced,
given the province’s history of under-building and low ownership
rates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
$ K2 e' K3 d2 U# s0 _+ l: t+ olimited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
6 [& t! N3 i7 w4 R) }) \( d2 khigh levels of apartment-style units presently under
construction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
' f# j0 s- C& w, z$ t. E4 v& icyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
4 L2 X" i! x8 m, [8 gresidential 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
years, which, along with improvements in affordability,
3 K8 R7 v$ q& `" N% x4 A) Lwill alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
/ q2 N8 x3 x: q  g$ VPascal Gauthier, Economist
416-944-5730
% a" L$ L3 n; @7 u: m9 X
http://www.td.com/economics/special/gb0409_housing_exec.pdf

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