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
3 F+ W. c% W1 B# y1 e# K+ c' sunsustainable levels of building. Our view is that house
prices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
7 e  T/ {, @, w% J$ j8 |overpricing compelled a level of residential construction
& Y$ z& p: L! n8 Athat exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
three years.
* ?8 [. V* f- f0 O4 i+ ?" sBy “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
( ^. j4 A3 p! Oaffordability. The current unwinding of house prices reflects
0 {# g' @) c  t& @7 Rboth a cyclical downturn and a return of house prices
6 T& T# K& m, L5 ?+ Cto fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
9 E- c3 Q0 B! F# Y4 D- Kwhere homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
0 G" N; h, G, Lthere is evidence of both types, we contend that Canada’s
+ R& z6 R( h. V/ V“overbuilding” was mainly of the first type, where
! C- S  _* K" W2 t5 J9 P# L8 m7 dhomebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
8 H' o/ x- B$ lthe construction of too many new homes over the boom
8 ]! ~) f1 L5 Qmeans a deepened slump. This overbuilding will likely weigh
8 s5 S5 d7 C$ G" _% Oon markets over the next few years. Even as Canada recovers
- L1 \: X) ]* yfrom the cyclical downturn, house price growth will
* P! }* ~) c4 |+ }% [remain choppy and new residential construction will be
( o- P" V4 @6 @dampened, owing to this structural weakness. Construction
9 X9 O: ]0 w2 b2 K5 v3 P$ Pis now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
3 ^  r, P1 F) ?residential construction will fall further to around
3 J- @9 L3 U. x8 d2 B125,000 starts over 2009 with a trough around 115,000 units
) C* n+ W: w) t# l% p1 R0 L) {: ?in the fourth quarter.
0 R' E* m. ?" ^' E" k7 QTo quantify the degree of overpricing and overbuilding,
we first develop an empirical model, based on long-run
fundamentals of house prices and housing starts in each
/ q0 Z! p1 S; B3 cprovince. Affordability is the key concept behind home
( G( r5 ^9 F" {values since house prices should track incomes over the
1 K( Z0 R8 u0 m! Nlong-run. Since homebuilders build to meet demand, we
( F/ F$ U6 n) ]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
# P! k5 x7 j% h2 doptimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
/ s) {1 I8 N2 ^7 ]. o- }units were being absorbed, homebuyers simply bought too
+ S# S5 N2 a: P! g- o) _many houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
7 }# F$ S0 Y% F  o8 \population inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
. U' {1 e" F( B* b& q  Nvery time that the resale market has swung into strong
, R+ a' b) d+ s/ a2 k8 v, Ibuyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
6 O% ?9 i1 }# E* @. B7 D2 V1 w1 {# ^weakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
% c: a: Z; L" nstrange accumulation of unabsorbed multiples on l’Île de
! |* m9 D% C- xMontréal – but recent building has been relatively balanced,
given the province’s history of under-building and low ownership
0 J) v" [% \5 r: ?3 |rates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
  K4 x1 P, q+ d& G+ \# plimited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
* p- G' C2 l. N) Whigh levels of apartment-style units presently under
. b8 d* U8 h' D# h) pconstruction 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
residential construction in B.C. will definitely droop, we
. a$ i7 e4 e. w/ R! q9 a) ?anticipate that the West Coast will continue to benefit from
inter-provincial and international migration over the coming
$ {8 x' e5 C2 c5 j8 tyears, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
' F  s4 z$ I5 O2 ?% n) D& n416-982-8063
  C  v& V- e! \+ S7 ^% }5 bPascal Gauthier, Economist
416-944-5730
; t* @( D8 A: y' _8 E5 I# d" l- K
http://www.td.com/economics/special/gb0409_housing_exec.pdf

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