TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
$ Y2 o( Y& Q9 _$ p9 Vfrom 2002 to 2008, unsustainable price increases drove
. O8 I  t  R' o( F! bunsustainable levels of building. Our view is that house
prices exceeded the value of housing that was justified by
0 ?- \) I1 o: J+ V; c$ z1 ifundamentals by approximately 9% nationwide. This
* l5 K. O# ?& c. p+ P" R! boverpricing compelled a level of residential construction
* h2 q+ Z* I! X+ C% {8 g9 ?+ ithat exceeded its fundamental-justified level by approximately
& L: g8 w, B* d/ N1 L$ V- c12%, an excess that was exaggerated in the past
three years.
: x+ T3 Z, S9 z+ x! D& G; jBy “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
( ]' f$ t" H4 \/ B0 D4 Jaffordability. The current unwinding of house prices reflects
both 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”
: V$ d5 F4 J8 p. }2 U- kwhere builders accumulate excessive inventories. Although
' I0 z* e$ z- ]; q, Z) ithere is evidence of both types, we contend that Canada’s
, q8 d/ ^0 n8 w“overbuilding” was mainly of the first type, where
" G3 c; k% }/ f* j4 M4 U, Thomebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
the 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
remain choppy and new residential construction will be
# K$ R$ p- {  k5 {+ sdampened, owing to this structural weakness. Construction
6 A- L& C: b7 T: S/ wis 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
+ Q9 E& v4 S* C  k. W5 D- W  z, qin the fourth quarter.
To quantify the degree of overpricing and overbuilding,
2 `4 s& X6 V$ Y: @) \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
values since house prices should track incomes over the
, ^: j! l4 `& T9 J6 a7 ulong-run. Since homebuilders build to meet demand, we
: a/ b- @3 b) L, yregard housing prices and household formation as the drivers
of residential construction.
To examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
8 l& u, p- M5 s# }) k' |0 z; z+ Swould have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
' R2 A2 N. w7 H6 |fundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
  d& Q3 g% _7 Y1 U8 G) Vmany houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
* n* \, j1 X  w: C* Xpopulation inflows. Saskatoon, Calgary and Edmonton are
( Z% t9 k( F7 Zalready witnessing surges in their unsold new homes at the
7 P' W5 t" X7 N# @% fvery time that the resale market has swung into strong
buyers’ territory. Homebuilding in the Atlantic provinces
- C; j5 |$ z$ ^6 V; S1 I) Y6 Nhas been relatively balanced but, while not plagued by structural
) w8 m5 {. r# j/ w7 k: f% ]weakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
3 e: D0 y9 c2 T. G5 u8 sstrange accumulation of unabsorbed multiples on l’Île de
Montréal – but recent building has been relatively balanced,
' k( J7 B9 W4 N& C, Z$ Rgiven the province’s history of under-building and low ownership
4 n$ {$ g9 w  urates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
; u0 S& Y* `# R: L- ?7 U( Ilimited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
+ U/ F9 s# ?5 o* Kconstruction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
/ x9 N3 I. V% v: W9 kspike severely – particularly in Vancouver. However, while
# n+ X/ h6 z5 @) \" Y9 l. cresidential construction in B.C. will definitely droop, we
anticipate that the West Coast will continue to benefit from
+ Y  J" B& I- d' Qinter-provincial and international migration over the coming
years, which, along with improvements in affordability,
* O& W: {8 D) V3 gwill alleviate some of the pressure from overbuilding.
. w  h5 S2 X6 A5 ZOVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
7 A* ?3 `4 s# ]; T+ A! mPascal Gauthier, Economist
416-944-5730

2 Y6 g) L$ q0 g. Y; k% yhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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