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
$ N1 V2 H/ I. [+ Ounsustainable levels of building. Our view is that house
  ]9 d+ G7 C6 V9 k2 uprices exceeded the value of housing that was justified by
fundamentals 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
8 V9 J4 t$ S1 u! Z$ Vthree years.
By “overpricing” we mean that prices detached from
+ F' f3 U& z8 Y$ ]6 atheir fundamentals, as witnessed by a steep erosion of
. b- I( ^7 }* N9 Oaffordability. The current unwinding of house prices reflects
both a cyclical downturn and a return of house prices
to fundamentally justified levels.
- P( `! }; X2 uWe consider “overbuilding” of two forms: “demanddriven”
* f, N, v. p4 j; bwhere homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
$ x; m. `! f2 s; o: {1 h4 J, ?# V8 tthere is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
9 f0 K) O& m/ v  P4 B; Y3 Shomebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
1 u5 b$ D) `, p2 a; ?While most markets won’t face U.S.-style overhangs,
9 q3 Q, S; D. y' y3 H8 q6 Sthe 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
3 r& @6 z0 j/ \; |2 r  Q% v2 fremain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
* J0 q/ o6 D) _3 g  m. i$ dis now undershooting fundamentals and we expect this
8 v/ m" p# [  L  C* `# Fto persist over 2009 to 2011. We anticipate that nationwide
residential construction will fall further to around
4 t" ]+ }5 B$ b. q125,000 starts over 2009 with a trough around 115,000 units
* W* ]( e2 l' H+ j, v5 @in the fourth quarter.
+ x9 O. V# {5 z& j; n! l+ @$ p6 R+ OTo quantify the degree of overpricing and overbuilding,
we first develop an empirical model, based on long-run
* c* k# m/ R4 mfundamentals 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
( |! i, O6 m* L5 z9 Sof residential construction.
' y- }$ u% _9 Z/ g4 @To examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
4 y) H- T  o" J9 j6 Runits were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
) \; M. c" J  Z! lpopulation inflows. Saskatoon, Calgary and Edmonton are
, G* k( ^8 e0 {/ kalready witnessing surges in their unsold new homes at the
very time that the resale market has swung into strong
! \/ ~1 j; N  j5 s9 }4 k) pbuyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
weakness, will be singed by the downturn nonetheless.
6 m' p2 _0 L" `Québec shows signs of strain – especially given the
+ Y" P9 a" Q) d; ^strange accumulation of unabsorbed multiples on l’Île de
Montréal – but recent building has been relatively balanced,
; i- C% U+ I/ _* z; Vgiven the province’s history of under-building and low ownership
rates. While Ontario homebuilding will reel from a
. `; i* i! i2 d* a6 ucyclical downturn, the degree of structural weakness appears
2 ^& L: v# w7 ~; {) A  mlimited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
& s. R* O. t0 B$ e8 Q0 d8 t+ vhigh levels of apartment-style units presently under
construction mean that record numbers of condos will
3 x$ w  F8 i! N+ N) ~reach completion during 2009. If absorption rates fall, as
$ M5 ^; X, X3 A: Lcyclical factors would indicate, condo inventories could
6 U: t# ]# X, K* h3 Espike severely – particularly in Vancouver. However, while
, K  }" C# b5 s% h7 n# D' nresidential 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,
% @( v" I1 s5 n3 y# F# uwill alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
( \) m$ I3 I' Y, _" V) L" X  I  kMARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
( S! b8 Q) p1 v) U416-982-8063
Pascal Gauthier, Economist
* ~5 s0 g" a# T416-944-5730
% `% ^. x1 ~" m$ w5 U/ W# i2 b9 C$ h" o8 C1 r
' F% x" }- _! e+ \. ghttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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