TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
+ ]3 d& A$ J2 w6 |# u7 }1 ifrom 2002 to 2008, unsustainable price increases drove
unsustainable levels of building. Our view is that house
* A# ]# b% N9 K6 p8 V# Bprices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
# ]9 O" |0 X3 p. aoverpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
three years.
7 c4 F3 @  k. z3 `By “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
  z7 ?+ N: s; S" jaffordability. The current unwinding of house prices reflects
8 h3 U3 p1 I0 d* h7 s( aboth a cyclical downturn and a return of house prices
. I0 D5 H  t% J5 R/ Oto fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
& H8 a* ~1 ?$ F4 S) G( g% Athat this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
( {: Z3 g9 }0 S# v) ?there is evidence of both types, we contend that Canada’s
4 r- p3 i! H* t- j# }“overbuilding” was mainly of the first type, where
  i8 {6 X2 e0 Y, \7 ]1 S3 N! f# K) \; ^homebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
' i. L, l9 m2 k% O% {: CWhile most markets won’t face U.S.-style overhangs,
" F; N; O1 [& ^0 Nthe construction of too many new homes over the boom
2 Z3 L! E8 j3 D! n1 p; D4 }means a deepened slump. This overbuilding will likely weigh
on markets over the next few years. Even as Canada recovers
, u4 A$ E5 T" x% K6 Rfrom the cyclical downturn, house price growth will
: z: }. I- o) z) ^0 F* Lremain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
" u. q5 P6 Y& c% jis now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
residential construction will fall further to around
7 J) e, V5 r* ^125,000 starts over 2009 with a trough around 115,000 units
* P) G' f/ {9 Jin the fourth quarter.
To quantify the degree of overpricing and overbuilding,
" \+ T/ W" m5 b# X' r- lwe first develop an empirical model, based on long-run
fundamentals of house prices and housing starts in each
) W5 s; e  E. G" T  \! Nprovince. Affordability is the key concept behind home
values since house prices should track incomes over the
. t, O5 c% b) hlong-run. Since homebuilders build to meet demand, we
6 L  N8 |8 n& {/ d- T! Z9 Zregard housing prices and household formation as the drivers
+ g/ Z+ l) n( |8 ~; g" |) A' tof residential construction.
To examine the degree of overbuilding, we employ a
, c+ a& U& v8 ~0 U+ Z  ^“counter-factual,” asking what level of residential construction
7 `5 }: D* H% C. ^would have occurred if housing had been priced
- {6 P. O2 Y9 Z! t7 O* Aoptimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
+ b3 e" D/ [6 c/ x! cmany houses at prices that exceeded fundamentals.
$ a  Z' |1 u& ]; T6 ~# K* i, e0 LRegionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
" m* s% {: R' u* `/ Gvery 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
$ G" u2 \" g& \/ M& G- ?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
Montréal – but recent building has been relatively balanced,
given the province’s history of under-building and low ownership
7 S0 k7 H  t5 F8 Q# O( qrates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
3 q# N. a0 @6 l' |( u) S# O* ?high levels of apartment-style units presently under
2 [, h7 R" ~4 P7 l! T! {0 gconstruction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
8 U4 |) o0 A& d) \! Tcyclical factors would indicate, condo inventories could
  t( E3 r1 E- a, y9 P5 P( Uspike severely – particularly in Vancouver. However, while
4 s5 a! q6 p5 t& p! y( H" Tresidential construction in B.C. will definitely droop, we
/ _8 j& A* g# U, k! g$ W6 ~- [1 M0 Yanticipate that the West Coast will continue to benefit from
& _7 ^4 G& [2 Dinter-provincial and international migration over the coming
( w. {5 o7 M+ g3 }years, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
* Z& z5 A( E; L, \' O4 S7 pOVERPRICED AND OVERBUILT: CANADIAN HOUSING
5 ?/ h6 v$ i/ \& q0 ^& B6 t5 qMARKET RETURNS TO FUNDAMENTALS
6 y, p+ ]9 _& c, C3 xGrant Bishop, Economist
416-982-8063
Pascal Gauthier, Economist
0 c' Z0 m0 j3 Z$ o7 c& @416-944-5730

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

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