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
2 `  A0 I3 o1 tunsustainable levels of building. Our view is that house
prices 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
: H% K* l. T4 c; V$ X12%, an excess that was exaggerated in the past
three years.
, A8 i, t* Y& J9 y7 Q' H) BBy “overpricing” we mean that prices detached from
# l; L- A$ p' O( p0 o! ?* rtheir fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
# j" C& s4 D0 f$ T8 w! iboth a cyclical downturn and a return of house prices
to fundamentally justified levels.
* w8 L0 C& U* J" e/ |We consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
" E/ H0 {1 ~+ q% m  ^where builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
3 r$ W$ H( }0 N  Y+ k- M“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
0 g  X3 e* c' C3 a1 d" B9 K+ \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
: [1 U" Z* |0 d# H8 fon markets over the next few years. Even as Canada recovers
7 d' W6 @) T$ `% ~; d" vfrom the cyclical downturn, house price growth will
0 ?( [1 e; h7 ^% c, ^remain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
" c% [# }4 H( p6 E4 \3 mis 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
in the fourth quarter.
To quantify the degree of overpricing and overbuilding,
6 ]  }' K5 X6 U. b# g9 C$ V6 [we first develop an empirical model, based on long-run
+ z- ~! H* C+ j0 ~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
long-run. Since homebuilders build to meet demand, we
) X0 J! L4 E7 ^& x7 V, _  A& |regard housing prices and household formation as the drivers
" w* U/ T- S6 |! v6 m; d0 Eof residential construction.
To examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
1 E- S3 J1 F# Y7 y5 e$ Ooptimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
( c5 J& \! ~6 a" s$ ^/ F# S: uunits were being absorbed, homebuyers simply bought too
5 r4 m0 R+ \8 P# {* P. |many houses at prices that exceeded fundamentals.
* W) h2 E/ ^9 E. ^Regionally, we see the greatest strains on the Prairies,
) v- p$ e& ?& I/ E, F- xwhere housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
0 q* {4 I; r9 y" t7 B, ^5 ]& Malready witnessing surges in their unsold new homes at the
very time that the resale market has swung into strong
8 g7 z7 `6 f' m" Bbuyers’ territory. Homebuilding in the Atlantic provinces
# N, s6 c4 ?/ |/ bhas been relatively balanced but, while not plagued by structural
weakness, will be singed by the downturn nonetheless.
5 `; U8 M+ L1 k4 d2 NQuébec shows signs of strain – especially given the
" b5 r4 K$ L) I& R/ q. Mstrange accumulation of unabsorbed multiples on l’Île de
Montréal – but recent building has been relatively balanced,
3 _" r5 p5 v6 J, j: Qgiven the province’s history of under-building and low ownership
rates. While Ontario homebuilding will reel from a
  U  N# R, @7 c& D" P. Scyclical downturn, the degree of structural weakness appears
+ D9 s/ |/ Z4 @+ x  Hlimited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
$ ~9 O( S6 k7 ^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
9 e: O0 L7 \! w8 cspike severely – particularly in Vancouver. However, while
( F: ~2 q/ Z9 hresidential construction in B.C. will definitely droop, we
0 i% d; g% r9 y* l! K% T" M5 [anticipate that the West Coast will continue to benefit from
inter-provincial and international migration over the coming
years, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
& H! n! r2 T% T8 }. QOVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
0 Q2 [+ b; j1 @+ D3 ?) qGrant Bishop, Economist
% p. F; G0 [- `& w& q) y416-982-8063
+ K3 w; H" J2 m* _Pascal Gauthier, Economist
416-944-5730

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

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