TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
' |" [" v% w# u5 g/ Hfrom 2002 to 2008, unsustainable price increases drove
unsustainable levels of building. Our view is that house
+ Q5 ^% p: H; I2 V1 N3 Zprices exceeded the value of housing that was justified by
8 ]$ {2 _6 S& ]$ Y$ pfundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
three years.
$ p9 m  R; T. z- k' ?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
both a cyclical downturn and a return of house prices
0 i! o! {! G/ i# E5 w& zto fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
3 W8 @7 h9 r* w5 b; h* A# Iwhere homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
6 [/ W( \, X% r8 fwhere builders accumulate excessive inventories. Although
: ]9 ~4 ]6 g- V& Z1 Athere is evidence of both types, we contend that Canada’s
3 e5 u( y7 z. P% S( L" O“overbuilding” was mainly of the first type, where
& A* L5 k( y% Uhomebuyers pushed homebuilding to an unsustainable pitch
+ D( b. B- ?+ q- Q0 `+ Vthat is now being rapidly reined in.
- `1 a$ o8 Z* Q; IWhile most markets won’t face U.S.-style overhangs,
the construction of too many new homes over the boom
  d) @" e: j9 e1 V9 |9 _means a deepened slump. This overbuilding will likely weigh
/ U& W6 g! R) T9 [1 X! {  z% o" c, \on markets over the next few years. Even as Canada recovers
from the cyclical downturn, house price growth will
0 J; E: \' f, e& a0 G+ sremain choppy and new residential construction will be
1 d7 ^* }0 c( h2 }dampened, owing to this structural weakness. Construction
, L" V4 n1 m6 n7 b9 Fis now undershooting fundamentals and we expect this
6 U6 P3 O3 e9 P) K8 Mto persist over 2009 to 2011. We anticipate that nationwide
residential 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,
# D: q" U/ T4 L0 r( B8 b& Jwe first develop an empirical model, based on long-run
$ v: t  r' m7 n+ S- |fundamentals of house prices and housing starts in each
4 S7 j4 O# Y; p: G6 t+ C/ Sprovince. Affordability is the key concept behind home
values since house prices should track incomes over the
1 {, w; f3 l0 p# t* glong-run. Since homebuilders build to meet demand, we
, @$ l; p4 S4 A  p% Uregard housing prices and household formation as the drivers
of residential construction.
2 o3 N" C5 e- c' ]" dTo examine the degree of overbuilding, we employ a
8 U8 v' z: F7 D# M, M' r“counter-factual,” asking what level of residential construction
% m; V" b. g8 vwould have occurred if housing had been priced
$ s- w4 T! [; I8 Joptimally. We find that actual homebuilding exceeded this
& P7 h% J1 f0 K0 {fundamental-justified level by about 12%. Although new
6 ?( v9 k, i) L8 g  Munits were being absorbed, homebuyers simply bought too
5 Z+ }  J4 C/ `many houses at prices that exceeded fundamentals.
' [" T+ {3 G) Q) ]* T' [Regionally, 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
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.
2 l! S, K8 o# b" N/ DQuébec shows signs of strain – especially given the
$ J! W9 u# P( Nstrange accumulation of unabsorbed multiples on l’Île de
: [- I8 \$ V+ i& VMontréal – but recent building has been relatively balanced,
given the province’s history of under-building and low ownership
( q  F8 |. D! M! d& trates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
( _5 @' C2 e% ?$ u; r) tlimited – with the important exception of the Toronto
$ B3 \9 g* V+ d7 C5 v4 {condo market. Both in Toronto and Vancouver, historically
7 x, h- \; H& o  h; Y7 B, G3 phigh levels of apartment-style units presently under
construction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
4 V, a( C* [; m4 q% d, icyclical factors would indicate, condo inventories could
% v  C% \& L1 Z  B$ Sspike severely – particularly in Vancouver. However, while
. t6 D1 U, i. k8 bresidential construction in B.C. will definitely droop, we
anticipate that the West Coast will continue to benefit from
- N% a+ I" Z; H& \1 winter-provincial and international migration over the coming
years, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
6 K/ K# B# C# @$ `5 vOVERPRICED AND OVERBUILT: CANADIAN HOUSING
8 F' _4 D3 x) c, m; D4 G. tMARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
3 B0 t; k& w+ t) e5 f416-982-8063
Pascal Gauthier, Economist
416-944-5730
' ?% {# _. e9 D! k7 z( k
http://www.td.com/economics/special/gb0409_housing_exec.pdf

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