TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
3 I: _3 f4 U2 x0 d; r: G, {* v3 nfrom 2002 to 2008, unsustainable price increases drove
unsustainable levels of building. Our view is that house
- b9 t3 i" E5 lprices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
; `; E. O6 _: R0 A! Qoverpricing compelled a level of residential construction
: K4 s# I5 @. K  c* m+ W1 q  [that exceeded its fundamental-justified level by approximately
2 e3 y" M1 j& W, c0 ]12%, an excess that was exaggerated in the past
2 ?  e* L; d' d5 W# f+ xthree years.
9 L: Y/ v' F: f( Q2 ABy “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
) E* A3 k) s4 h! i8 `, Wboth a cyclical downturn and a return of house prices
to fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
) T3 q0 a! J7 W% T' o! tthat this demand cannot be sustained; and “supply-driven”
. G& l% ?" [! m) pwhere builders accumulate excessive inventories. Although
" H0 Y4 f5 X7 K$ I& F2 Xthere is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
; J0 h7 ~. B- _1 yhomebuyers pushed homebuilding to an unsustainable pitch
! Y) I3 ?& ~2 G( u6 |that 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
' K, E/ i4 ?* l1 u. kmeans a deepened slump. This overbuilding will likely weigh
1 h( ?8 y, |  I2 b4 @1 G+ j& Qon 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
. B0 m; P' p) jdampened, owing to this structural weakness. Construction
4 e) M9 p" A1 }7 `& o, j  Kis now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
residential construction will fall further to around
' Z. T* \' s$ R6 ~, q9 v/ {. p125,000 starts over 2009 with a trough around 115,000 units
, z- D) k  H) z( {in the fourth quarter.
, J6 l% Z8 b- ITo quantify the degree of overpricing and overbuilding,
we first develop an empirical model, based on long-run
/ v' R* ?* ~4 s2 ^  Y6 K$ sfundamentals 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
3 I2 `) n, U# _* I8 Aregard housing prices and household formation as the drivers
of residential construction.
, s6 `6 p- p! WTo 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
6 U5 z4 w6 G" I8 ]fundamental-justified level by about 12%. Although new
+ f8 W  r$ t- Y1 a+ qunits were being absorbed, homebuyers simply bought too
4 g+ i: D9 ]/ ]  o% ]- cmany houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
4 T/ n* _, {2 d/ E0 [6 Lwhere housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
1 T3 \, z) P# c( u4 ]already witnessing surges in their unsold new homes at the
very time that the resale market has swung into strong
& F$ {; u( s& O7 i. j( @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
. m0 o* x5 f4 T5 OMontréal – 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
( f* u/ o; y% F$ x/ _limited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
construction mean that record numbers of condos will
8 s' c/ o0 {2 B7 I( preach completion during 2009. If absorption rates fall, as
& a) b* _% g. C; T2 u! Z& Z7 }cyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
( A6 M( W3 D) G4 M4 |5 G2 _+ w' fresidential construction in B.C. will definitely droop, we
anticipate that the West Coast will continue to benefit from
& z+ ^4 W# c0 B4 H. |" J/ uinter-provincial and international migration over the coming
! c! `! l% |9 Z, ayears, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
: e  @2 f# S; {# M& `9 M2 NMARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
: r+ L$ n- n, O9 PPascal Gauthier, Economist
& W5 E  i. H! ?- w" G$ T! L' Y416-944-5730

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

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