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
5 Y* |' c/ w4 y- `  A, A' Nunsustainable levels of building. Our view is that house
prices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
# d' a9 H0 e% h; s  h1 _7 hoverpricing compelled a level of residential construction
* \( k" [( ^- t6 j+ jthat exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
% `  E: |0 [) x( @  q4 K8 m( w5 ]three years.
  ?; K0 u1 \& j, k) s- s" QBy “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
5 v# k! N) w* p% i. `* }- E/ Gaffordability. The current unwinding of house prices reflects
both a cyclical downturn and a return of house prices
6 j+ B& b/ Z8 N) R; Z- E4 `to fundamentally justified levels.
% T! d: I$ ]! U$ WWe consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
0 }& y, [' ^6 E; g7 |* Mthat this demand cannot be sustained; and “supply-driven”
, \$ S4 z# e/ Q7 \6 r5 xwhere builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
, _" d% P# @3 w! q4 J6 i, I6 N) K$ D" {homebuyers pushed homebuilding to an unsustainable pitch
, F2 @+ Q# m) Bthat 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
, I$ `8 q1 T" ^/ o; m/ ?5 Zmeans a deepened slump. This overbuilding will likely weigh
1 ]: E3 j+ S5 ~( A% aon markets over the next few years. Even as Canada recovers
+ V$ A2 F7 I7 b7 C7 vfrom the cyclical downturn, house price growth will
" ]7 `8 Q( n4 {4 }+ G; q5 Q6 O: X* rremain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
& o0 U. o  N7 h1 g3 His now undershooting fundamentals and we expect this
9 h; y/ b/ U. d3 M7 `to persist over 2009 to 2011. We anticipate that nationwide
+ h; N" d" @, J. [/ Bresidential construction will fall further to around
+ R$ H$ U) e- K7 r/ y1 d% `$ a! z125,000 starts over 2009 with a trough around 115,000 units
! x1 z3 I. y" C) `$ ]in the fourth quarter.
To quantify the degree of overpricing and overbuilding,
we first develop an empirical model, based on long-run
+ d+ e& p4 V/ E" |) pfundamentals of house prices and housing starts in each
' J' P6 s1 F( f  \6 s' zprovince. 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
3 p3 b5 |# }) mregard housing prices and household formation as the drivers
of residential construction.
To examine the degree of overbuilding, we employ a
& f$ m: ^4 w3 D8 T4 m% M) [1 F3 p& t“counter-factual,” asking what level of residential construction
9 T6 e* Z7 x" B8 j/ gwould have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
) Z! t1 J( b; J7 s/ e& X$ ~1 _fundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
: f* L$ I; C$ h! K9 Hmany houses at prices that exceeded fundamentals.
2 h* H- L: z/ o! U" DRegionally, we see the greatest strains on the Prairies,
: y+ h+ @; y. H; n# b8 twhere housing demand will further contract under waning
: L8 y+ I4 C5 Y4 a" o# z/ L* epopulation inflows. Saskatoon, Calgary and Edmonton are
* `/ Q& [! @9 v" kalready witnessing surges in their unsold new homes at the
very time that the resale market has swung into strong
* S6 h/ u0 [/ i8 F  u: e. ~: s/ z* xbuyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
, \9 D  u+ N" M& kweakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
' r, h8 T/ j7 V% b# o1 b! Sstrange accumulation of unabsorbed multiples on l’Île de
' k7 l2 d9 M6 a  a8 Q4 K. YMontréal – but recent building has been relatively balanced,
given the province’s history of under-building and low ownership
8 {' K1 K' h' `6 y- n, Srates. While Ontario homebuilding will reel from a
3 M! C4 J3 D1 S+ U) A; A( x$ U4 p1 pcyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
1 @7 A! _2 C. i& Econdo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
  j( f* N6 |7 E3 K; O3 ]# @1 wconstruction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
3 F  P6 f0 x# }( ]& Z1 Qspike severely – particularly in Vancouver. However, while
5 m) r5 m) \9 Presidential construction in B.C. will definitely droop, we
anticipate that the West Coast will continue to benefit from
2 i* M% T; c* ]6 y" h! m6 Qinter-provincial and international migration over the coming
years, which, along with improvements in affordability,
% X5 F0 g+ d! |* a$ n, Lwill alleviate some of the pressure from overbuilding.
& i  G8 U6 }8 |: S  YOVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
Pascal Gauthier, Economist
. T! t9 L' ^8 J416-944-5730
* m9 {9 b  h  G  T9 m
http://www.td.com/economics/special/gb0409_housing_exec.pdf

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