TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
6 D+ `2 s( [  Zfrom 2002 to 2008, unsustainable price increases drove
* P2 a# d& Q0 p1 A) junsustainable levels of building. Our view is that house
7 I! {/ k$ Y3 c5 S, Z9 C# Dprices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
0 ~, B7 H4 _5 b12%, an excess that was exaggerated in the past
three years.
By “overpricing” we mean that prices detached from
, z/ S3 \: S( r& j2 stheir fundamentals, as witnessed by a steep erosion of
2 l  d7 l. [! \, j5 h) k4 baffordability. 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”
- n6 B* F! s7 d& Zwhere homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
5 v5 |: P* q, _* g, b1 qwhere builders accumulate excessive inventories. Although
/ e% b( O4 S0 T; D/ d# cthere is evidence of both types, we contend that Canada’s
1 M; W4 Y  v8 `5 [# Y! t5 k# b“overbuilding” was mainly of the first type, where
* e7 w1 y& B; n, }homebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
9 f1 U9 I& p( o, w% QWhile most markets won’t face U.S.-style overhangs,
, a5 ~0 L( s% Qthe 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
' q4 A+ O) B7 ~7 K0 z" udampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
/ `# _; K) D4 T' f9 T) I7 uresidential construction will fall further to around
; v  m/ h  u  f  N: i7 q" `2 c125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
2 v6 w) ]2 n) E. d" H2 H4 @  m7 VTo quantify the degree of overpricing and overbuilding,
$ h' X% s" u9 Gwe first develop an empirical model, based on long-run
" D) b' z9 r5 m/ ], }fundamentals of house prices and housing starts in each
5 D; [" B/ q, u  Dprovince. Affordability is the key concept behind home
values since house prices should track incomes over the
long-run. Since homebuilders build to meet demand, we
9 ?* j; P7 O8 u! S- @$ xregard housing prices and household formation as the drivers
of residential construction.
( C: O6 b3 F# e' a- S( gTo examine the degree of overbuilding, we employ a
  Z! M5 \9 S! d$ r“counter-factual,” asking what level of residential construction
7 y% e( x  B5 q* ?7 qwould have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
' p* u4 b1 J; L, k; _# Z9 H0 Jfundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
' D) F. E; S* O4 C( nmany houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
0 g- R; ^" U! Ipopulation 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
has 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
strange accumulation of unabsorbed multiples on l’Île de
/ z7 S5 }7 n$ w/ w# @! ^Montréal – but recent building has been relatively balanced,
; }0 k) A4 D$ D' g# ^- Q4 {7 jgiven the province’s history of under-building and low ownership
6 X3 G3 D& ?( `1 I  i# p1 irates. While Ontario homebuilding will reel from a
6 s1 ^1 f7 {* f7 ^cyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
2 h1 b" K2 h4 @+ a2 ?0 r, |  x3 B) k( mcondo market. Both in Toronto and Vancouver, historically
4 S: D6 m. R- nhigh levels of apartment-style units presently under
, F: w" M' _$ x' P5 U; e* nconstruction mean that record numbers of condos will
5 N# Y6 G) {7 M2 S0 ^* Z3 sreach completion during 2009. If absorption rates fall, as
( W, C; h, ?% ~. Dcyclical factors would indicate, condo inventories could
  K( U5 L& D, R, N" c5 H' @0 B' xspike severely – particularly in Vancouver. However, while
residential construction in B.C. will definitely droop, we
  v. y8 y; B# ]7 Z! _5 G0 Canticipate that the West Coast will continue to benefit from
  x/ Y# |) B! O" e0 }1 e; I' ?inter-provincial and international migration over the coming
years, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
' U3 c( U. t2 cMARKET RETURNS TO FUNDAMENTALS
' e' w. m. S7 M& d% l) M0 J, wGrant Bishop, Economist
% P7 Y$ H/ I7 p; ^416-982-8063
Pascal Gauthier, Economist
; ]- [1 R/ l, a- w0 G416-944-5730

$ I3 }5 s0 C! f+ f8 L5 O; ]" @5 Lhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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