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
' a0 S8 B, N8 Punsustainable levels of building. Our view is that house
' W. n7 Y% i  J9 O* w% Lprices exceeded the value of housing that was justified by
3 d5 V- [5 r& C0 ?5 ~- hfundamentals by approximately 9% nationwide. This
5 W7 h$ p* n, s( {/ Eoverpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
+ R* x% b2 L( `12%, an excess that was exaggerated in the past
three years.
By “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
# O5 @, E) I4 g3 {/ N8 O! }4 G9 D$ Aboth a cyclical downturn and a return of house prices
( b* i, k$ M: g6 F/ y: fto fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
- u! n% L$ e' Z) v, pthat 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
“overbuilding” was mainly of the first type, where
3 X) ]: W6 X" ~homebuyers pushed homebuilding to an unsustainable pitch
  K# L: a: L* n4 othat is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
* o; P( p' b2 x7 h7 V) @7 ^9 ]the construction of too many new homes over the boom
means a deepened slump. This overbuilding will likely weigh
+ O; d. ?4 y( L: k& ]3 fon markets over the next few years. Even as Canada recovers
$ }7 N- h" I  W; s, E/ X0 T/ Ufrom the cyclical downturn, house price growth will
remain choppy and new residential construction will be
3 {7 ~( f6 U( m% I. m$ V* x8 I! cdampened, owing to this structural weakness. Construction
! S/ `) W1 ~* A- Y  t" Zis now undershooting fundamentals and we expect this
0 r9 R/ {" Z/ i8 `, K; o% bto persist over 2009 to 2011. We anticipate that nationwide
& N, N1 L8 ~8 D0 J5 c' Z$ i: Uresidential construction will fall further to around
/ I! N5 S6 d1 i' `0 f125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
: ^6 j6 @$ v  w6 A- @, ?To quantify the degree of overpricing and overbuilding,
8 \6 E+ {& A  D5 A+ Z3 I( Nwe first develop an empirical model, based on long-run
1 t2 g  L, f, I& tfundamentals of house prices and housing starts in each
" T3 \9 w& a& p+ A9 d, N2 pprovince. Affordability is the key concept behind home
values since house prices should track incomes over the
8 `1 H4 T* B8 f( {5 U3 D# h0 d2 Wlong-run. Since homebuilders build to meet demand, we
regard housing prices and household formation as the drivers
) Y7 Z! A" }3 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
0 \% x9 e4 J  Q7 M! Foptimally. We find that actual homebuilding exceeded this
- F5 _. A5 ^+ Y$ W9 Y$ ufundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
9 l/ X; ~  S' ]# Q0 `, smany houses at prices that exceeded fundamentals.
$ Y" z4 f  M: m0 N9 A; wRegionally, we see the greatest strains on the Prairies,
3 n7 i+ O, g# ?where housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
2 z- ]% {3 H% n# xalready witnessing surges in their unsold new homes at the
$ K( Y0 E, T: N+ Mvery 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.
* [4 }  t9 W( J# \+ m" D* F$ i$ PQuébec shows signs of strain – especially given the
( s: A2 G* g' e! nstrange accumulation of unabsorbed multiples on l’Île de
0 [: L, Q" o0 h, A  ]7 Y: U- ~' nMontréal – but recent building has been relatively balanced,
4 A: D" t: h0 d0 g" y6 O8 e6 [given the province’s history of under-building and low ownership
% Q, Z  I' J6 t1 [# {rates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
: X9 @" R5 h$ l7 Z- _limited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
: d& V, P# G$ ]' o5 Y2 L6 t% Khigh levels of apartment-style units presently under
construction mean that record numbers of condos will
. k) r  w% ~1 I; Mreach 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
anticipate that the West Coast will continue to benefit from
inter-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
MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
Pascal Gauthier, Economist
; ]. f6 f9 W: \& {416-944-5730
) ], w/ ~( \# b& d8 s" y9 Z
http://www.td.com/economics/special/gb0409_housing_exec.pdf

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