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
' {/ a) G" I3 v& R7 }* Y: Eunsustainable 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
6 T) d* G1 Y4 Gthat exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
+ T' T5 [* Y0 `: D3 Uthree years.
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
" o! p- K' {' T% m# w9 nboth 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
that 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
5 L6 z5 w  c. a' q6 }4 @homebuyers pushed homebuilding to an unsustainable pitch
) s, @) c' X& `* [. y8 @- Y( tthat is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
; i2 L; h$ |) Q$ r" z  Kthe construction of too many new homes over the boom
1 e' Z6 r6 {1 L1 N/ cmeans a deepened slump. This overbuilding will likely weigh
on markets over the next few years. Even as Canada recovers
0 s4 B7 R$ ^7 K: F9 ]5 g* @from 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
  K- u# A% V; w4 \residential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
7 Y" Z1 [1 t/ G: A- a9 {# M) vin the fourth quarter.
' n  M5 J- {/ m1 bTo quantify the degree of overpricing and overbuilding,
0 r; e4 Q2 x1 }7 p# ywe first develop an empirical model, based on long-run
4 }, X/ m( r7 G8 P4 V! Wfundamentals of house prices and housing starts in each
2 T" G- F5 B" i  m9 E4 W  rprovince. Affordability is the key concept behind home
+ P  w0 K# v7 k1 j3 D! I7 c! A, ?values since house prices should track incomes over the
, x8 N0 \) G5 c2 v' wlong-run. Since homebuilders build to meet demand, we
5 l# \, C. Z" e2 x6 P( bregard housing prices and household formation as the drivers
7 {! R/ {( ]8 c: n# }. a+ fof residential construction.
( V3 N6 F! c# R" O$ t: ~To examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
* j& Z+ ~' m% e& u' _- M" e7 Soptimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
& @" B+ h3 C$ ^9 m1 E' l; S4 l; Uunits were being absorbed, homebuyers simply bought too
0 t" ^" ^. o# N" x1 smany houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
! y4 `  Q. A8 h' ]3 wwhere 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
buyers’ territory. Homebuilding in the Atlantic provinces
- n! J% X" @; H) v3 hhas been relatively balanced but, while not plagued by structural
1 |. t6 i1 @7 G. s+ [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
9 s# e2 p; V$ P, a  hMontréal – but recent building has been relatively balanced,
: x, e0 T# Z/ S  }+ J6 m* mgiven the province’s history of under-building and low ownership
/ a! z) G3 q( V4 o! lrates. While Ontario homebuilding will reel from a
. s6 }9 _' m0 z9 p3 o% Qcyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
, A: H% @2 S$ }% Hcondo market. Both in Toronto and Vancouver, historically
% J0 F. N1 K- `+ u+ ihigh levels of apartment-style units presently under
construction mean that record numbers of condos will
/ H& P1 D3 y# b: zreach completion during 2009. If absorption rates fall, as
$ X+ A; u$ F' @+ y/ |! M( Ccyclical 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
: |* {9 K; d# L5 t/ {inter-provincial and international migration over the coming
8 I% b, N; }3 W/ i, N% iyears, which, along with improvements in affordability,
! Z3 Q1 @! T/ T* P. Z+ w" |will alleviate some of the pressure from overbuilding.
1 ^9 d$ g  f; Y" \  \" C5 OOVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
, U2 b  s, i4 r8 t1 _416-982-8063
Pascal Gauthier, Economist
416-944-5730
5 Y* n* a- A6 ^) t7 a" X( Y- R
http://www.td.com/economics/special/gb0409_housing_exec.pdf

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