TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
5 L% g# k# N, E' Tfrom 2002 to 2008, unsustainable price increases drove
. L0 y" |. Y% f& Q5 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
, Q. a' m3 A" I/ Noverpricing compelled a level of residential construction
3 E; w& B) `& |. A' x5 Mthat exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
6 Q; x5 u2 c. P& u2 t7 b2 g4 e! vthree years.
: b5 \' u  Z9 a  |. T  jBy “overpricing” we mean that prices detached from
their 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
to fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
/ s$ \* _) {8 ^where homebuyers buy up too many houses and
3 K  L0 x- Z6 @1 n$ {: h; Hthat this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
) Y; d9 f. ~# Tthere is evidence of both types, we contend that Canada’s
/ Q+ _4 w2 u( y; e& g$ M" c. D“overbuilding” was mainly of the first type, where
$ K+ e( Q; {  j5 T  t2 c. G$ phomebuyers pushed homebuilding to an unsustainable pitch
/ G- l& m; `3 b; @( b2 y6 F5 Fthat is now being rapidly reined in.
) j5 d1 `# ]$ \3 HWhile most markets won’t face U.S.-style overhangs,
" _& K+ k! w' ^" K, ]: lthe construction of too many new homes over the boom
" i5 R: E3 p4 u9 A; Kmeans a deepened slump. This overbuilding will likely weigh
on markets over the next few years. Even as Canada recovers
! `: B/ h' O5 t& k* h. J% ]from the cyclical downturn, house price growth will
remain choppy and new residential construction will be
, H6 `+ J4 J  z5 w8 L6 ~  Ydampened, owing to this structural weakness. Construction
( Y: a5 f# ^* a) g8 Q; Tis now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
0 d( L0 M7 K) D% tresidential construction will fall further to around
. S9 b- x  _9 ]# E5 J8 d125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
To 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
province. Affordability is the key concept behind home
5 @& m: h6 q7 o! d- t5 }. mvalues since house prices should track incomes over the
- l" Z1 ^5 f) V: w, Ilong-run. Since homebuilders build to meet demand, we
regard housing prices and household formation as the drivers
$ z8 F$ k% Y" V& ^of residential construction.
To examine the degree of overbuilding, we employ a
+ v, a7 a$ O2 J3 d“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
$ O' X0 R% _4 T( E6 |optimally. We find that actual homebuilding exceeded this
* E5 U* `3 `% xfundamental-justified level by about 12%. Although new
# ^$ N, n; F7 N4 Dunits were being absorbed, homebuyers simply bought too
; F! M% ^( \( x0 z" emany houses at prices that exceeded fundamentals.
* j7 H, {9 y( mRegionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
population 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
1 B. F% e& ^6 m  \- f4 Fbuyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
8 u/ h  E: S1 b. k9 @weakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
1 y# D# C( g' d3 h; P1 h$ Ystrange accumulation of unabsorbed multiples on l’Île de
Montréal – but recent building has been relatively balanced,
given the province’s history of under-building and low ownership
) s6 G$ y9 y; B( N+ ^9 t0 m( rrates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
! c# n# ~8 e: l/ [/ V4 _limited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
  X  \- `, A! x* `! zhigh levels of apartment-style units presently under
# G8 _+ {- h) [6 i4 T3 nconstruction mean that record numbers of condos will
, n( i, j9 i: }0 mreach completion during 2009. If absorption rates fall, as
5 ^# Q" [% N/ {+ Fcyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
residential construction in B.C. will definitely droop, we
2 b+ {1 R% H: x) E0 ranticipate 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.
4 O4 n- }+ e. y' r. I) cOVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
Pascal Gauthier, Economist
4 D1 U  L/ m/ t4 S416-944-5730

" q9 u* x& f& W' Q. Ghttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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