TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
3 U3 o9 b3 a0 Q0 \# L3 l$ N$ jfrom 2002 to 2008, unsustainable price increases drove
unsustainable levels of building. Our view is that house
5 S" R8 J. |! w0 jprices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
- [% B  n8 P% F( z% o* ~3 f# toverpricing compelled a level of residential construction
1 @# A1 S9 K8 P7 Cthat exceeded its fundamental-justified level by approximately
% m) E! U5 B# z/ @% e/ S12%, an excess that was exaggerated in the past
three years.
0 U7 t- X- \' s2 dBy “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
" j: L- U- t4 r# N0 ]+ {7 e9 fto fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
( m* n' e/ N( e; t9 T, lwhere homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
: _: \% Q( X( ]7 Z4 c9 lthere is evidence of both types, we contend that Canada’s
1 W" O: S5 r( l“overbuilding” was mainly of the first type, where
8 Z' r; G) m" a+ Y: Ehomebuyers pushed homebuilding to an unsustainable pitch
8 x" U0 Y$ {4 I: U7 Q6 lthat is now being rapidly reined in.
2 v0 Q4 t$ w. w$ V4 ZWhile most markets won’t face U.S.-style overhangs,
( i4 F' T8 b  c! o- ithe construction of too many new homes over the boom
& y6 U0 M8 ^$ b$ B, s9 _1 Gmeans a deepened slump. This overbuilding will likely weigh
* Q' v/ M5 G0 m3 r1 eon markets over the next few years. Even as Canada recovers
* N, N3 ~3 K; l5 n# P3 l1 Ufrom the cyclical downturn, house price growth will
/ f# n& |- K" {5 D3 h$ n4 e0 n/ lremain choppy and new residential construction will be
: k# d# X* X, `. Odampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
6 y+ @2 _" m* w8 [1 pto persist over 2009 to 2011. We anticipate that nationwide
+ ~: q- U+ m$ C, V: G2 s# nresidential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
: m7 i: A- J% U! ]; W4 r6 ?in the fourth quarter.
To quantify the degree of overpricing and overbuilding,
( Z- x5 t- ]7 J+ X9 L- e4 Zwe first develop an empirical model, based on long-run
- M& a8 K# \" d/ Y; S( R0 `fundamentals 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
long-run. Since homebuilders build to meet demand, we
regard housing prices and household formation as the drivers
of residential construction.
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
* f7 u! N6 Z$ v3 {optimally. We find that actual homebuilding exceeded this
3 K/ \# n+ X, \7 k2 H1 M* Y( z: K; Cfundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
- D! w) Y2 U2 Z; S' N. v7 V/ l  Q0 f; zmany houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
- i1 J6 O& X' p) g% b0 R4 Rwhere 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
* e% b* z+ o* k% S+ Xbuyers’ 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
1 O, ?, z3 |5 n# |( r6 E& _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
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
  [3 ~( W5 V& 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
) e% ]) p8 W+ ?% Gcyclical factors would indicate, condo inventories could
5 b$ i3 S, n# @$ _  z) s- ?6 v/ i+ \spike severely – particularly in Vancouver. However, while
residential construction in B.C. will definitely droop, we
! N! @* M" K4 y+ k+ V: D9 uanticipate that the West Coast will continue to benefit from
inter-provincial and international migration over the coming
& K) {2 {: F3 y0 j$ o- tyears, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
6 E1 L# z; c% oOVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
- y  [8 g' c! M1 M; C416-982-8063
! J9 A) F  S+ J$ Z+ tPascal Gauthier, Economist
' |! Z1 n6 r7 c+ v" g( W416-944-5730

; a2 W) ]9 o1 c9 c- p* chttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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