TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
from 2002 to 2008, unsustainable price increases drove
/ W6 c; V; j- h, Yunsustainable levels of building. Our view is that house
prices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
9 Q2 r8 ?! N) R8 j" d# Ioverpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
/ c2 H" B! I, ?1 C; }6 a/ a- l12%, an excess that was exaggerated in the past
three years.
By “overpricing” we mean that prices detached from
, J! m, r6 U; i3 Ptheir fundamentals, as witnessed by a steep erosion of
; s: q; Z8 ~( |6 R( u6 daffordability. The current unwinding of house prices reflects
4 ?" ~3 N# {, Q* o9 Y# Cboth a cyclical downturn and a return of house prices
* @& F* r+ K; ~4 _, Jto fundamentally justified levels.
+ P% G9 L7 A8 R9 F3 k  r6 i9 R0 O! wWe consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
" {" B0 L7 l5 uwhere builders accumulate excessive inventories. Although
' J9 Z7 G. Y7 H% l5 N0 S+ Wthere is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
" A2 p# \# S: W* kWhile most markets won’t face U.S.-style overhangs,
/ U) h2 }  k6 ^" \& ]' a2 ethe 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
& I0 A0 t1 u0 X8 X7 g" O" j* S( |remain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
9 e2 N# e& N. p7 [- Lis now undershooting fundamentals and we expect this
+ \5 d/ t1 J3 v6 f+ M+ f% ito persist over 2009 to 2011. We anticipate that nationwide
residential construction will fall further to around
% z" q# J$ I/ m4 i! Q0 _125,000 starts over 2009 with a trough around 115,000 units
5 g1 }2 @3 e- j, ?in the fourth quarter.
6 l; c8 ]6 A! q2 CTo quantify the degree of overpricing and overbuilding,
( F6 H" O7 u2 s& @; Y+ ]- iwe first develop an empirical model, based on long-run
  m8 |! c- B  j- a  U: N0 yfundamentals 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
  e+ _- m/ ?0 cregard housing prices and household formation as the drivers
( u% m- Z2 n0 k* Mof residential construction.
9 u! f. s7 @. E" i' R1 h% bTo examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
* V5 A, H' D8 K7 g- toptimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
% i3 D8 N2 j) ~- [% |many houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
$ Z+ B! {: Z! }0 o, r/ iwhere housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
& [; |1 W, p  @# |1 R( xalready 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
6 q. b( F1 X& t4 r/ y. m+ Oweakness, will be singed by the downturn nonetheless.
! Z% _. Y, H8 G. \8 |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
* A/ ?2 D/ \2 o# Q7 rrates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
& y5 T4 o! X6 [limited – with the important exception of the Toronto
$ A6 U1 Y; x$ }7 g+ ]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
# c' Y0 R8 l+ r- z  l8 m- P# zspike severely – particularly in Vancouver. However, while
residential construction in B.C. will definitely droop, we
anticipate 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 D& a+ @3 B7 E: `: I. |) K  aOVERPRICED AND OVERBUILT: CANADIAN HOUSING
0 M7 [0 |% z" @( _+ v/ T3 U2 e& x% P7 @MARKET RETURNS TO FUNDAMENTALS
2 e: z" z% ^; p3 xGrant Bishop, Economist
% d. j5 K( J0 \/ r( A5 |- F416-982-8063
Pascal Gauthier, Economist
, ~& y2 p' }8 Q416-944-5730
6 d, O- H4 C$ {" m  D- T& I$ q& z
$ ~# P' C; F9 r9 G& Ohttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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