TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
3 F0 F! T+ D( M: B" hfrom 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
fundamentals by approximately 9% nationwide. This
& u0 q, F0 Z4 b: koverpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
0 ~) ~6 b. ~5 @) R' e: qthree years.
8 z. |3 H" [5 O4 q; ^8 Y/ H& h3 `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
2 c. U! x$ Z% X5 e1 ]both a cyclical downturn and a return of house prices
. v$ b% a$ g4 I1 G: q2 o' Mto fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
3 Y( ]2 m! E: @. N$ S$ S9 b& [there is evidence of both types, we contend that Canada’s
. T2 M+ M5 C9 N  M9 l: W“overbuilding” was mainly of the first type, where
! N  `% R/ N- @6 o# Nhomebuyers pushed homebuilding to an unsustainable pitch
- @2 P3 R4 F1 s8 bthat is now being rapidly reined in.
$ z0 \8 |) w( A3 F' qWhile most markets won’t face U.S.-style overhangs,
$ b0 ~4 Z% C  r' w6 B. l9 qthe 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
" ]& L3 n; d% G+ j! R& p; u" lremain choppy and new residential construction will be
: y. m. z: d% d' xdampened, owing to this structural weakness. Construction
$ U/ {% G9 F( V' a6 fis now undershooting fundamentals and we expect this
* x" ]2 v/ I9 Y7 ?1 Gto 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
0 v$ N+ T. \1 P5 I2 w9 `" V" Lin 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
values since house prices should track incomes over the
long-run. Since homebuilders build to meet demand, we
regard housing prices and household formation as the drivers
" G5 [: ~- K" P& R( h0 n! w% Yof residential construction.
To examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
, u3 z1 ~- z8 C& D0 P, d- @would have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
5 }' J( y  h$ m2 m& j  lfundamental-justified level by about 12%. Although new
' u8 i- T; J+ p7 G: Aunits were being absorbed, homebuyers simply bought too
1 |1 g) T' y8 v, g4 ~0 m+ ymany houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
; S! c1 [% c8 G& N! ]population inflows. Saskatoon, Calgary and Edmonton are
9 l$ j9 M$ L) r( C( f$ U# ?" j$ ralready witnessing surges in their unsold new homes at the
# M# ^) j3 A9 y) ]5 U# Vvery time that the resale market has swung into strong
buyers’ territory. Homebuilding in the Atlantic provinces
4 `" H5 x. E9 t& Q3 v1 whas 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
  x. l, \, u# o0 h7 ~strange accumulation of unabsorbed multiples on l’Île de
Montréal – but recent building has been relatively balanced,
4 z, A4 X. A+ j; bgiven the province’s history of under-building and low ownership
# W( |( l0 c. k5 E0 g+ E$ {rates. While Ontario homebuilding will reel from a
. y7 t5 I5 G/ ^% Lcyclical downturn, the degree of structural weakness appears
3 D' e6 [+ B& v' K- m: ilimited – with the important exception of the Toronto
5 s: Q9 ]% O( }: u5 i: d, n3 Xcondo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
construction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
" G6 e/ `- {- j" y7 B; jcyclical factors would indicate, condo inventories could
" h/ a& q! C$ Hspike severely – particularly in Vancouver. However, while
! J7 J$ U9 _2 |7 A' fresidential construction in B.C. will definitely droop, we
) N1 s$ w; g1 G0 [; r1 F$ Panticipate 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.
2 y0 B9 ?  ]# X4 L4 W: Q9 ]OVERPRICED AND OVERBUILT: CANADIAN HOUSING
! L: D( u; z- p- y, W  TMARKET RETURNS TO FUNDAMENTALS
% i: k: g) @$ M7 {# RGrant Bishop, Economist
0 y2 ~4 }# X$ [7 Q% H416-982-8063
Pascal Gauthier, Economist
5 r& y* M/ k; |2 K) v3 H/ X. R416-944-5730

3 |! q, B+ c, k* F6 k* X. Whttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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