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
' j9 }1 p6 o8 j' t7 runsustainable levels of building. Our view is that house
prices exceeded the value of housing that was justified by
- _9 J" H0 f0 C' w5 S4 N1 mfundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
9 ?* S/ X' g9 @$ y  A12%, an excess that was exaggerated in the past
2 T. [/ }  F: v% g" V; Athree years.
$ E8 H/ \6 ]2 G& N: {8 LBy “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
  F; i7 v5 N, m$ Q; H- b0 Aboth a cyclical downturn and a return of house prices
: a/ `( S& h. _. m5 `/ Eto fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
: p' ~' E" B+ ?* mwhere homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
6 V: Z: ?. D9 D) z5 I2 }* Gwhere builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
. Q# @; p7 E6 n* c# G0 E$ T“overbuilding” was mainly of the first type, where
, |! \; k: U5 _8 e( `! D7 n/ `homebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
  C2 k9 n1 M  d3 C  M8 N+ G! sWhile most markets won’t face U.S.-style overhangs,
( |8 F( P& K0 T. s- Kthe construction of too many new homes over the boom
# K: _0 c" p5 b& @: Y$ mmeans a deepened slump. This overbuilding will likely weigh
on markets over the next few years. Even as Canada recovers
( q) Q6 z8 C7 W0 V2 Pfrom the cyclical downturn, house price growth will
remain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
/ O1 Y, f" \9 L8 V/ p: e  his now undershooting fundamentals and we expect this
to 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
in the fourth quarter.
To quantify the degree of overpricing and overbuilding,
' y3 s* ?# v) a# U+ Hwe first develop an empirical model, based on long-run
  y3 B6 L* `0 F8 Ofundamentals 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
: B3 x; i4 v# C- C! X' ~6 K8 ], \long-run. Since homebuilders build to meet demand, we
regard housing prices and household formation as the drivers
& P; g9 T* q4 A8 k; z: }! Sof residential construction.
To examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
/ Y! K' d+ N; e2 nwould have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
( U9 m! T* m6 Wfundamental-justified level by about 12%. Although new
' [3 g/ U" \7 ^$ D. E  ?: yunits were being absorbed, homebuyers simply bought too
) i) Y. t. H1 a( b4 d! Wmany houses at prices that exceeded fundamentals.
0 |  W8 ^2 q+ p; f* k& X$ tRegionally, we see the greatest strains on the Prairies,
9 a4 b4 g9 O% i9 E" S  ?where housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
2 P. Q* ^! }2 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
weakness, will be singed by the downturn nonetheless.
9 H$ ^( o; l; t3 }  Y2 x$ r- XQuébec shows signs of strain – especially given the
# ^( y1 I, M5 b4 v" M3 {8 ?strange accumulation of unabsorbed multiples on l’Île de
$ f/ s3 O- i' f. N! q( u1 ~$ w. bMontréal – but recent building has been relatively balanced,
% W; v8 y3 e' o+ @; r6 vgiven the province’s history of under-building and low ownership
rates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
$ I) c/ d  J- k" mlimited – with the important exception of the Toronto
. ^- g- I. W  G9 X% Hcondo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
8 }. ^7 Q: A' D0 Qconstruction mean that record numbers of condos will
+ Y* a4 ?- E8 f  Z+ L4 ureach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
" g! E  n5 l& L" V/ j9 Y+ M4 Wresidential construction in B.C. will definitely droop, we
anticipate that the West Coast will continue to benefit from
! X- F; }$ U/ J0 X9 d: kinter-provincial and international migration over the coming
years, which, along with improvements in affordability,
9 t( J; m( _6 u0 J1 b: I, nwill alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
$ n  V# m' g* T, q  x  pGrant Bishop, Economist
416-982-8063
& t" L* E, N# z( J4 R9 XPascal Gauthier, Economist
" Z6 y" {5 H  @, c2 F416-944-5730
* {- I' D; }' V' H3 a
http://www.td.com/economics/special/gb0409_housing_exec.pdf

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