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
. @6 v9 ~0 E% o& X* ]. W4 a2 Funsustainable levels of building. Our view is that house
  W1 ^3 c  ^; u8 o) ~* P" Yprices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
' M( n' ~' U0 z( y3 x8 i6 M* L, P7 koverpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
; ]4 _8 J% P0 m) _% k12%, an excess that was exaggerated in the past
  D: j) q- W, g4 m4 Q* Wthree years.
2 z2 u: c. j8 X2 r; R. wBy “overpricing” we mean that prices detached from
- Q" l! s5 D, I  l/ utheir fundamentals, as witnessed by a steep erosion of
* I4 _" K$ _! f% Maffordability. The current unwinding of house prices reflects
: `% ^1 }! T* A" G+ |  tboth a cyclical downturn and a return of house prices
to fundamentally justified levels.
) n9 U. ^0 L$ g. V8 V% v2 ~We consider “overbuilding” of two forms: “demanddriven”
$ O  e- ~% Q3 x; Z% K( Kwhere homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
: u. e+ F* j9 H" i8 [) @0 m“overbuilding” was mainly of the first type, where
/ S" c$ ~- m9 G7 B( g  Zhomebuyers pushed homebuilding to an unsustainable pitch
/ C! c0 I: R5 \" h6 Cthat is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
. a9 N+ X1 p4 i9 e9 Cthe construction of too many new homes over the boom
  Q2 P* [4 Y- q" |9 emeans a deepened slump. This overbuilding will likely weigh
4 R+ y1 @; g0 l% @6 Q/ ion markets over the next few years. Even as Canada recovers
+ c/ B, N( B" C* v9 a: U* K/ o4 W9 v. pfrom the cyclical downturn, house price growth will
  K, U5 {; f% I1 ~remain choppy and new residential construction will be
3 k* W% b/ M2 u3 p" M2 ^dampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
* V+ @/ v9 s( i* [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,
we first develop an empirical model, based on long-run
  |, `1 l- l+ p0 X* ]- Tfundamentals of house prices and housing starts in each
6 e) k( a) _& D8 u' Sprovince. Affordability is the key concept behind home
( f5 k; z: u, x2 k* zvalues since house prices should track incomes over the
0 c3 \( V, ]' Q! c* zlong-run. Since homebuilders build to meet demand, we
7 q/ D5 J* B* `& ?  t: `* Vregard 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
' h! U; s# n9 x2 ~! Swould have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
' D7 F0 `7 i# L4 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
! u  d2 C$ y% _4 f+ ]very time that the resale market has swung into strong
' y4 W7 }! `4 Nbuyers’ territory. Homebuilding in the Atlantic provinces
$ X. g/ u9 t( i# F( }+ ?& Q6 lhas been relatively balanced but, while not plagued by structural
! Q! k" R: j" g0 U/ Yweakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
3 x4 ^( f' x% _  v2 h! Z# k5 pstrange accumulation of unabsorbed multiples on l’Île de
Montréal – but recent building has been relatively balanced,
3 C" S- B* C5 I+ _given 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
9 z3 B- _" _, Tlimited – with the important exception of the Toronto
. f8 Z7 k- Z4 M7 Kcondo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
construction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
8 f0 k+ w  g9 Z8 hspike 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
) d8 e+ {2 _& N" syears, which, along with improvements in affordability,
' o9 z; p6 `% n) J  v  ^3 w  `1 H0 Pwill alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
5 A1 Z( v; ~7 ]3 T9 a% B) pMARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
Pascal Gauthier, Economist
416-944-5730

http://www.td.com/economics/special/gb0409_housing_exec.pdf

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