TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
) A2 A, a1 k+ p% k4 P$ Q0 E% g2 Mfrom 2002 to 2008, unsustainable price increases drove
8 w& e& H& ]0 j1 k& z7 C9 @4 D0 Nunsustainable levels of building. Our view is that house
) y0 C% _% W' X0 V( G( B! t# Tprices exceeded the value of housing that was justified by
# @# t! y" L& lfundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
  ~2 O8 a  ]- u3 \that exceeded its fundamental-justified level by approximately
) J- m- X9 W! j8 H1 Y1 R12%, an excess that was exaggerated in the past
three years.
! Q! G, p% `7 U" v2 rBy “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
5 D  S; M: d) |$ u6 _4 kaffordability. The current unwinding of house prices reflects
; p" L9 }0 G4 ]4 C% k  k- Fboth a cyclical downturn and a return of house prices
to 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”
' z7 E+ T6 t8 Y: uwhere builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
: L$ q4 H. i9 ]“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
! \4 H* w! c- R/ J. @; pthe construction of too many new homes over the boom
9 v# ^4 m; j" b# X# x; E; d1 B( rmeans a deepened slump. This overbuilding will likely weigh
- i/ Y8 v, z. con 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
- _: R" T& n0 i/ `) j/ Gdampened, owing to this structural weakness. Construction
, A/ _7 A' m. Q$ U; ?" f7 Nis now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
# t4 m; Z; p3 k# a7 Uresidential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
To quantify the degree of overpricing and overbuilding,
- Z6 K- x, v, j- e" {7 }we first develop an empirical model, based on long-run
fundamentals of house prices and housing starts in each
4 U7 L/ h! V/ z' l4 `! @0 k- Sprovince. Affordability is the key concept behind home
9 s7 z+ n$ Q; V2 ]* `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
  _  c6 q0 c3 _  r' m: m/ s+ ]of residential construction.
To examine the degree of overbuilding, we employ a
. A4 e5 Y- k; `/ l5 h“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
5 J3 d1 Y; d# N- e- m; ~4 y$ \optimally. We find that actual homebuilding exceeded this
8 h# _3 P  i1 {* i% n4 ]fundamental-justified level by about 12%. Although new
+ M- n  A/ T2 Z7 tunits were being absorbed, homebuyers simply bought too
9 U" f/ S1 G! w7 n/ Dmany houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
- B, j3 D/ I  _. F1 m* ?6 @$ Zwhere housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
already 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
' w' N3 C2 C1 L7 h- thas 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
- u+ s) V2 H# X3 B5 f- Mstrange accumulation of unabsorbed multiples on l’Île de
( Z4 N1 _" q5 f% U8 A% [! YMontréal – but recent building has been relatively balanced,
! P2 m1 @- O- a3 X$ x  `given the province’s history of under-building and low ownership
% u3 O8 J/ X& hrates. While Ontario homebuilding will reel from a
% y3 ~/ O! H6 h+ Ecyclical 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
. Y5 r1 R5 `2 ^5 e$ `/ b, q7 Zconstruction mean that record numbers of condos will
: j- J. t5 E8 k& T- k  Yreach completion during 2009. If absorption rates fall, as
( u7 k# i3 o) l" j6 @cyclical factors would indicate, condo inventories could
6 j4 m2 S9 d1 U2 l$ Gspike severely – particularly in Vancouver. However, while
residential construction in B.C. will definitely droop, we
' `+ }  K& N& f" n! Oanticipate that the West Coast will continue to benefit from
inter-provincial and international migration over the coming
. g7 \$ Q# x( Lyears, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
6 v& O1 }1 ]. a$ K9 @OVERPRICED AND OVERBUILT: CANADIAN HOUSING
  I- Z4 l) w& u" d1 L$ ]9 t# ]MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
7 ?5 B9 i$ p# m' v416-982-8063
Pascal Gauthier, Economist
416-944-5730

8 e) Z% q+ R& ~% i3 L7 I  }2 vhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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