TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
( P5 g6 l% A' [- }$ n7 W" k; ffrom 2002 to 2008, unsustainable price increases drove
" N) s) Y# v7 [# Nunsustainable levels of building. Our view is that house
prices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
2 U. R2 T* {) E( Loverpricing compelled a level of residential construction
: X4 t. @6 b) i$ Athat exceeded its fundamental-justified level by approximately
: S2 F& r' [8 c" G12%, an excess that was exaggerated in the past
three years.
% a( \0 r2 J* [9 G1 u  NBy “overpricing” we mean that prices detached from
5 t0 d( p/ m5 ~1 W) Y$ u& p' otheir 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
; D' C$ A; x% ?1 [; D) q" {to fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
1 g: p' v6 j8 ^7 S: G; J8 d  twhere homebuyers buy up too many houses and
  G# k  t; g6 Z  |$ lthat this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
! O4 E9 _8 H+ n1 S: qthere is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
8 z# @0 F# b& w% x7 ?0 Q  |While most markets won’t face U.S.-style overhangs,
% \* W$ {! ?7 M  m/ f& bthe construction of too many new homes over the boom
means a deepened slump. This overbuilding will likely weigh
  X0 _5 r2 B' F9 don markets over the next few years. Even as Canada recovers
1 V' }( G, u1 n1 U8 V$ w* }& H1 xfrom the cyclical downturn, house price growth will
remain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
9 Y+ n$ ~5 c- g! n9 [. vis now undershooting fundamentals and we expect this
; p$ Z, l& @0 E& f4 dto persist over 2009 to 2011. We anticipate that nationwide
1 a, s' |5 ]3 ?- O/ b9 w$ J( cresidential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
To quantify the degree of overpricing and overbuilding,
( O. J- a' o0 I% a/ j0 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
  J: n0 N) C, z: f2 R+ B- a0 }1 Vvalues since house prices should track incomes over the
  d& X: P; x- i( c6 }% Hlong-run. Since homebuilders build to meet demand, we
regard housing prices and household formation as the drivers
+ {4 |9 }; x9 C2 ^) |* T% Cof 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
optimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
  p# a# \+ T8 i2 V. Junits were being absorbed, homebuyers simply bought too
! S* O3 \2 w0 ~: X1 \& Qmany houses at prices that exceeded fundamentals.
# v8 \2 h% v3 K+ g# I" h' b* NRegionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
: |' O; ^4 R  Ypopulation inflows. Saskatoon, Calgary and Edmonton are
  a% D+ A: F% I6 ^& s' kalready 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.
: |( X; F7 k) TQuébec shows signs of strain – especially given the
2 o" `8 W" G% M. `: astrange accumulation of unabsorbed multiples on l’Île de
  b" q! ^! |9 ]8 A8 S/ cMontréal – but recent building has been relatively balanced,
given the province’s history of under-building and low ownership
. K% c& ~0 {3 p+ @2 v+ U+ {rates. While Ontario homebuilding will reel from a
' Y  D- \8 \* \+ W7 O8 x+ F/ ucyclical downturn, the degree of structural weakness appears
+ T/ O, X' C9 s1 [- c" F+ ]7 v; vlimited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
1 ?" @1 ]. Y5 E; E/ Xhigh levels of apartment-style units presently under
construction mean that record numbers of condos will
4 a6 ]& k  i+ T) l! i, N' Rreach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
7 J) c! D5 ]2 T3 s/ R: ?8 e/ sspike severely – particularly in Vancouver. However, while
residential construction in B.C. will definitely droop, we
* e' O1 f* y$ j* i5 Banticipate that the West Coast will continue to benefit from
8 U6 Z! A9 J8 a; V7 @) V8 F! {inter-provincial and international migration over the coming
# v. e0 {- N5 y0 Lyears, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
6 `. ?/ Z' S5 o3 v: `OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
* q" Q6 W: j# `; Q9 w5 S1 BGrant Bishop, Economist
5 H6 }0 A' f! Y2 n8 d5 y+ r416-982-8063
Pascal Gauthier, Economist
" W, G; I# n  _7 Y1 a' N$ d416-944-5730

http://www.td.com/economics/special/gb0409_housing_exec.pdf

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