TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
' H3 b% u0 X7 x+ C' f5 v# a4 Zfrom 2002 to 2008, unsustainable price increases drove
; J4 b/ T( U- B) dunsustainable levels of building. Our view is that house
" T9 ?) t  e. l) ^prices exceeded the value of housing that was justified by
* L5 O( {: @$ xfundamentals by approximately 9% nationwide. This
0 f! k  k& @4 i9 M( I/ f; g( D: poverpricing compelled a level of residential construction
. _1 F2 V6 D5 k# }* gthat exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
three years.
+ b; |! T9 u3 Z( J5 w2 Z# J- U4 jBy “overpricing” we mean that prices detached from
' J, }3 N& c: j  S0 Otheir fundamentals, as witnessed by a steep erosion of
3 N. s: n1 x) ]  Waffordability. The current unwinding of house prices reflects
both a cyclical downturn and a return of house prices
! n% X) _& V6 h7 o; f3 H) R/ @to fundamentally justified levels.
5 l) T! P' b- |7 P: z' l$ RWe consider “overbuilding” of two forms: “demanddriven”
  w* F" q  h* B: y2 ^+ ~where homebuyers buy up too many houses and
* z5 t: H/ A& C! l. pthat this demand cannot be sustained; and “supply-driven”
4 j) l; H) }& }* ~0 }where builders accumulate excessive inventories. Although
/ t9 n- `: L1 z7 h2 d: Kthere is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
" {' }9 w, |. }: }homebuyers pushed homebuilding to an unsustainable pitch
1 Y/ C3 A& y( ~that is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
6 f: I8 Q3 P8 p; t3 M3 Sthe construction of too many new homes over the boom
- R7 c/ O% u9 Dmeans 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
remain choppy and new residential construction will be
/ p$ |1 U& @# U9 [: Z0 e7 N6 Ddampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
4 F3 [2 \1 _) t% A  _+ lto persist over 2009 to 2011. We anticipate that nationwide
residential construction will fall further to around
) A( J' p& l0 _; p1 n. r125,000 starts over 2009 with a trough around 115,000 units
in 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
8 |  j; t4 O6 ]* E1 X! [values since house prices should track incomes over the
long-run. Since homebuilders build to meet demand, we
# |' A7 L1 y( @$ sregard housing prices and household formation as the drivers
of residential construction.
To examine the degree of overbuilding, we employ a
& k* @- @! s3 d# I7 s9 c$ k6 n“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
6 y$ A, K2 J7 `" F4 s  H4 s/ wfundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
1 Z9 x# H" {1 r# ?# Q# y$ yRegionally, we see the greatest strains on the Prairies,
, S9 y2 i& l  q+ B, Twhere housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
/ A- G7 ^' Z* V: t4 b6 h* E- Galready 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.
; J7 z6 ?1 O  M7 V7 a/ IQuébec shows signs of strain – especially given the
( l" U+ c$ z- @" Z6 Kstrange accumulation of unabsorbed multiples on l’Île de
$ `6 T( p9 z( o# eMontréal – but recent building has been relatively balanced,
given the province’s history of under-building and low ownership
& D5 v. g2 d5 r+ n! {* t9 ]rates. While Ontario homebuilding will reel from a
, ]; I. q% i7 Y+ f) F+ T  Ucyclical downturn, the degree of structural weakness appears
0 n4 U% w1 \; @* N# x2 }limited – with the important exception of the Toronto
0 \) J& a% d# S* J4 E, ^$ Ycondo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
6 r$ \+ a/ Y" zconstruction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
; v  b7 ]2 D" Acyclical factors would indicate, condo inventories could
" {; `3 p3 z+ f" Xspike 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
$ @; E6 F$ P& s5 X6 qyears, which, along with improvements in affordability,
  W4 ~& d1 O7 h3 A/ K8 lwill alleviate some of the pressure from overbuilding.
( N0 Z1 E* E5 R" kOVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
! |* p3 I7 L  w* u" IGrant Bishop, Economist
1 l' M+ G' m) X( f& j7 ^416-982-8063
- g; w7 m, g2 l7 J+ q* vPascal Gauthier, Economist
416-944-5730
* R) [6 T' S6 Y! T$ w. o) m
2 i  E+ q2 i! E  t' H" W/ Nhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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