TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
8 M. J, i4 I) T+ ^/ mfrom 2002 to 2008, unsustainable price increases drove
6 [3 s. {6 V$ @, F) uunsustainable levels of building. Our view is that house
prices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
. v- h/ f/ O, j2 E/ y1 }overpricing compelled a level of residential construction
7 w- u4 }$ U) y) F5 o; [$ b8 Zthat exceeded its fundamental-justified level by approximately
' w* w1 w- D( {2 c. @. X12%, an excess that was exaggerated in the past
1 K* D7 V7 ]% Y0 C) ithree years.
By “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
+ D, z3 r" s6 naffordability. The current unwinding of house prices reflects
both a cyclical downturn and a return of house prices
' k& S1 p" q& cto fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
% K- ]8 a* n+ J5 E9 ithat this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
3 ?: m2 D( g* r* k/ e  Qhomebuyers pushed homebuilding to an unsustainable pitch
3 ^  U7 `% U, `* x  c: K: gthat is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
/ B5 ]8 S# S3 E# S! P& othe construction of too many new homes over the boom
" r  G" C, Y/ T$ K1 Mmeans a deepened slump. This overbuilding will likely weigh
# d8 \7 M: a6 M* \1 bon markets over the next few years. Even as Canada recovers
' N) y4 G+ e& `0 Pfrom the cyclical downturn, house price growth will
remain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
4 X5 N1 C& J- c. s" ais now undershooting fundamentals and we expect this
, K5 C% N9 I2 f- L3 Qto 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
" U8 o' c- a# oin 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
% o+ E6 t' p- Bvalues 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
) q; q( ]% q$ F2 `+ y+ E& T5 [of residential construction.
To examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
) c7 {: |0 N3 T  z4 W0 }/ [7 v3 Lwould have occurred if housing had been priced
! r& d6 @. D+ M1 noptimally. We find that actual homebuilding exceeded this
! Y* @" K( z& Y# ~) bfundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
5 k3 U" e: }& N. v0 Lwhere housing demand will further contract under waning
9 [6 s9 @9 {" |( i. X8 p' vpopulation inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
3 w$ H7 {/ N2 J1 C6 |9 e1 F3 Tvery time that the resale market has swung into strong
/ U. w$ A) X. Y# |4 [$ Ybuyers’ territory. Homebuilding in the Atlantic provinces
! y- }& g8 k2 o) X0 j6 }has been relatively balanced but, while not plagued by structural
9 J6 I7 ~+ }- B' w4 Mweakness, will be singed by the downturn nonetheless.
2 Q- `7 {! m  ]9 _: J' dQuébec shows signs of strain – especially given the
' h8 \8 Y, |/ i- d+ u7 Qstrange accumulation of unabsorbed multiples on l’Île de
4 M% e/ M1 H, A/ z, }' KMontréal – but recent building has been relatively balanced,
2 G6 ^, G+ ?" o& U) zgiven the province’s history of under-building and low ownership
rates. While Ontario homebuilding will reel from a
: `7 E# Z8 L' |( ]7 z1 wcyclical downturn, the degree of structural weakness appears
# B& t- ~) Y  L0 ylimited – 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
reach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
6 D1 h7 X( i5 u1 D8 t/ L2 Vspike severely – particularly in Vancouver. However, while
, c8 \* E- o0 }! L7 v7 Qresidential construction in B.C. will definitely droop, we
+ d7 c; H/ v- U5 lanticipate that the West Coast will continue to benefit from
# p; L1 H$ b- k7 y; D# P! f9 i) }3 Yinter-provincial and international migration over the coming
8 t6 |, P- k9 g: h; @years, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
( ^/ q# S6 T% N. ]8 s# ]7 v416-982-8063
Pascal Gauthier, Economist
1 k/ q- {6 r& f2 v3 l. n. ]- M% p' S416-944-5730
6 W7 a0 v8 j! k8 `. M2 ]2 ]
http://www.td.com/economics/special/gb0409_housing_exec.pdf

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