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
6 X& O/ ]9 m2 u0 S2 O: }5 Z" ]prices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
  [. L" B8 l; o0 F+ O) [; zthat exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
" W: R+ ~0 u$ Xthree years.
& E+ C; h( `- ]( ~0 D: \- Z! t# hBy “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
7 p. u& `+ u4 l8 a  Uaffordability. The current unwinding of house prices reflects
both a cyclical downturn and a return of house prices
, u# ]: M3 |$ F6 k* r; u) lto fundamentally justified levels.
, ~6 L+ q- h2 m7 r% N" n. iWe consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
1 P! D+ l$ c( ~2 q2 ?7 B& pwhere builders accumulate excessive inventories. Although
* X* Z: U) z* Bthere is evidence of both types, we contend that Canada’s
; i( [; \3 Y( x8 }0 u% h6 ^“overbuilding” was mainly of the first type, where
* U* s6 n* f3 e9 Q) U5 fhomebuyers pushed homebuilding to an unsustainable pitch
0 z* J$ R3 w' ~9 S1 O! Sthat is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
the construction of too many new homes over the boom
means a deepened slump. This overbuilding will likely weigh
1 i8 B/ h; K+ C9 _, v4 m! Q) X3 U9 Aon markets over the next few years. Even as Canada recovers
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
) H2 x" [- l. o; j; E  l- rto persist over 2009 to 2011. We anticipate that nationwide
) L# t2 m, _3 [+ lresidential construction will fall further to around
% _' f6 C4 i# ~. x4 F- o6 U. b125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
2 Q: R0 f: Q7 T  o4 B$ JTo quantify the degree of overpricing and overbuilding,
% X; d3 H1 V3 pwe 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
values since house prices should track incomes over the
long-run. Since homebuilders build to meet demand, we
. Y- Z' @" O. u: e4 i) z+ eregard housing prices and household formation as the drivers
! g( T2 H: T0 w. v* G$ O* B; q0 Jof residential construction.
To examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
0 ]" ?3 y! G1 Wwould have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
) G; e' S: F6 W3 G  x4 Zfundamental-justified level by about 12%. Although new
0 s) n8 l7 f& }) o. uunits were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
$ T8 o, q/ d" J. MRegionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
- L  I- Y- p& O. k% W4 npopulation inflows. Saskatoon, Calgary and Edmonton are
/ E3 P! J3 H2 aalready 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
strange accumulation of unabsorbed multiples on l’Île de
4 @! D1 h8 F& C1 zMontréal – 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
8 z" l  Y# ~0 e9 U, I# vlimited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
& ^" P; P$ \1 U9 ohigh levels of apartment-style units presently under
- v* h$ q9 _8 u2 L0 A  qconstruction mean that record numbers of condos will
$ U* H# U' b& `" S3 r" rreach completion during 2009. If absorption rates fall, as
/ s& j0 t' G! A" r0 Ecyclical 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
* O1 o. g7 ]3 k8 `% y# Q2 ginter-provincial and international migration over the coming
7 U& y1 k) s( A' n% A7 l1 P& o& Tyears, which, along with improvements in affordability,
3 h3 c' [) K  @, ^8 c, [  i6 J! Jwill alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
4 @8 x' J+ p9 nMARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
Pascal Gauthier, Economist
416-944-5730
. g5 f$ G- P6 x8 _5 O
; {" R+ W" ~) W8 Mhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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