TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
+ c# n( d8 U( u/ |: J  Vfrom 2002 to 2008, unsustainable price increases drove
unsustainable levels of building. Our view is that house
prices exceeded the value of housing that was justified by
  H3 V; m1 O' Z; E0 Efundamentals by approximately 9% nationwide. This
8 X$ l, I! k" `( Ooverpricing compelled a level of residential construction
' j+ K* X& \3 k0 q- q! dthat exceeded its fundamental-justified level by approximately
3 y2 I% Y+ Q4 ?$ H+ g" U& x12%, an excess that was exaggerated in the past
three years.
8 R' M1 G* _% G1 J. uBy “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
& f) w( _" Y$ [; U$ Wto fundamentally justified levels.
+ `6 b! U$ ?# [+ i3 HWe consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
4 J) t! I% p# _' b3 a" V# a' Awhere builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
- Q3 j  b9 T- S3 r; p“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
+ O8 `8 P3 ^0 j" R- k- o% Vthat is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
  X/ k+ U& N& Hthe construction of too many new homes over the boom
means a deepened slump. This overbuilding will likely weigh
on 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
dampened, owing to this structural weakness. Construction
, [% H6 Z( k; z9 Y* Wis now undershooting fundamentals and we expect this
to 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
% Q0 M5 h, E# _+ l  Nin the fourth quarter.
8 [- m8 n, @) a: }' ?To quantify the degree of overpricing and overbuilding,
we first develop an empirical model, based on long-run
( q- W# Y2 ~' t( I1 F7 pfundamentals of house prices and housing starts in each
7 _* m# V+ S% N5 ~" zprovince. 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
$ h5 u& ]" o5 J" H1 iregard housing prices and household formation as the drivers
of residential construction.
To examine the degree of overbuilding, we employ a
6 e: X# t0 ^8 J5 I/ D' n7 i" x) E“counter-factual,” asking what level of residential construction
+ z2 i+ ?3 Y( J1 L* y& Y- cwould have occurred if housing had been priced
; `; I; J  `; Ioptimally. We find that actual homebuilding exceeded this
' v, S* T4 f! ^) p: p+ t2 hfundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
+ v8 S$ D& X, m. O/ S1 Dmany houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
) l) P+ e3 i8 {: swhere housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
' J1 \0 q6 ^( d* f  G  F7 K3 P5 [already witnessing surges in their unsold new homes at the
very time that the resale market has swung into strong
: U8 e! q" R& T; a- b! cbuyers’ territory. Homebuilding in the Atlantic provinces
$ V9 `! K+ H$ m# y" chas been relatively balanced but, while not plagued by structural
7 y& e( h; I1 C5 _3 G5 B! ^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
Montréal – but recent building has been relatively balanced,
given the province’s history of under-building and low ownership
3 p# B! M: M* K4 l1 k( arates. While Ontario homebuilding will reel from a
- p7 y# K, x4 A" x! Y" Pcyclical downturn, the degree of structural weakness appears
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
* P5 v* _6 N$ v2 F: ~6 sreach completion during 2009. If absorption rates fall, as
1 \9 r6 L9 L- {1 |/ ]cyclical factors would indicate, condo inventories could
! c( Y1 O$ C, N2 P/ _! Wspike severely – particularly in Vancouver. However, while
3 g: k0 W( e/ A" J( P0 Iresidential construction in B.C. will definitely droop, we
+ \8 ]+ c1 V$ x6 N4 Qanticipate that the West Coast will continue to benefit from
inter-provincial and international migration over the coming
: K% B: o/ O/ i& b. m( j' Fyears, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
7 D) A" [4 R6 @5 {9 Y( E) xOVERPRICED AND OVERBUILT: CANADIAN HOUSING
  x# s, F  H% L1 e7 bMARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
Pascal Gauthier, Economist
5 s; r1 R7 ?$ |416-944-5730

1 @: @' L$ x$ a' A2 Y" Rhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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