TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
( W; u! H# X* e' N/ r" q  v$ [- sfrom 2002 to 2008, unsustainable price increases drove
unsustainable levels of building. Our view is that house
" z5 e# A3 c* S/ v( u! Hprices exceeded the value of housing that was justified by
( F! S4 H7 t- G: y: k2 T5 @fundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
1 U; U3 w( `6 V* h0 Xthree years.
( X; ^9 o. i. {$ m/ N% UBy “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
: y- h$ l2 L& c# B4 Z; Uaffordability. The current unwinding of house prices reflects
both a cyclical downturn and a return of house prices
to fundamentally justified levels.
4 U; G( V$ Y9 v7 Y7 vWe 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
" {! u9 o" W- R“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
8 h  |  C( \( L, Pthat is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
the construction of too many new homes over the boom
means a deepened slump. This overbuilding will likely weigh
on markets over the next few years. Even as Canada recovers
7 g, y. \- P4 w3 g$ P% h( ufrom the cyclical downturn, house price growth will
. x$ [6 V( u8 d/ a$ m( ]remain choppy and new residential construction will be
+ E  s) s7 P: j+ K' \1 }. N6 Wdampened, owing to this structural weakness. Construction
3 N& ]- U0 G0 F( Z! T1 R1 Iis now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
residential construction will fall further to around
1 d' Y  c5 p4 j' `125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
To quantify the degree of overpricing and overbuilding,
0 n) k% b! r# s6 Y* X- }) qwe first develop an empirical model, based on long-run
8 }7 v- m# o2 P8 }8 `  }. Zfundamentals of house prices and housing starts in each
province. Affordability is the key concept behind home
values since house prices should track incomes over the
# `9 L  B' e& n; S- blong-run. Since homebuilders build to meet demand, we
; T' q# g  t4 C' ?+ o$ ]  R1 \regard housing prices and household formation as the drivers
( ~8 v9 B% n7 \) i& ^of residential construction.
To examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
1 v( S6 K  I8 g' D2 v) c; i# c. Swould have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
5 n/ ~  s( v! _0 d% [$ Lunits were being absorbed, homebuyers simply bought too
* J5 c5 y6 y# m& W5 Umany houses at prices that exceeded fundamentals.
2 k" c" v! D/ c' zRegionally, we see the greatest strains on the Prairies,
; G8 J, O/ [# I  n; j$ Hwhere housing demand will further contract under waning
4 y% L# I) k1 ~' c. H) mpopulation 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* @5 N; j. N" d6 Sbuyers’ territory. Homebuilding in the Atlantic provinces
* m) h0 L& q* ~has been relatively balanced but, while not plagued by structural
8 P" _+ N- D- G* R; jweakness, will be singed by the downturn nonetheless.
3 ]' q9 g7 K( QQuébec shows signs of strain – especially given the
7 T5 [, w  @& {: hstrange accumulation of unabsorbed multiples on l’Île de
5 n' [, f9 k6 m. BMontréal – but recent building has been relatively balanced,
5 s. p. f& v; n7 Z$ }; p' G# egiven the province’s history of under-building and low ownership
2 p. m7 I1 o, _# N0 U! Lrates. 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
" |! k/ d4 Q' H3 ~high levels of apartment-style units presently under
3 e) ?% I4 }6 g: E$ M$ hconstruction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
6 O5 ~( i7 r9 w, |residential construction in B.C. will definitely droop, we
; t# w$ @" O; Q' tanticipate that the West Coast will continue to benefit from
! V' n! T/ z9 d( {# cinter-provincial and international migration over the coming
years, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
3 M0 i" n4 w) k) KMARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
. V; Y& _% {5 k  z+ n- t) [416-982-8063
- f+ Z3 @+ z% m# @7 T* }# \7 bPascal Gauthier, Economist
( v' g" m6 b0 d/ K7 c416-944-5730
/ Z6 [+ w; I) u
7 ?6 m5 t+ d4 z1 {" O  Q  N7 |http://www.td.com/economics/special/gb0409_housing_exec.pdf

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