TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
: l+ _5 U, v/ Mfrom 2002 to 2008, unsustainable price increases drove
/ x9 K" i& K' u6 y/ a( y' T9 X6 Xunsustainable levels of building. Our view is that house
prices exceeded the value of housing that was justified by
) _! K& s( P: h2 E7 O- {fundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
6 R8 S4 J  j' _. h12%, an excess that was exaggerated in the past
9 u% M4 l& o; ethree years.
9 p' o- m. t, f2 z7 J. EBy “overpricing” we mean that prices detached from
3 Y+ L' n7 d2 r( }' o+ W6 n' ~their fundamentals, as witnessed by a steep erosion of
/ z( ]! a" [0 K4 `4 d9 o. p9 H. waffordability. The current unwinding of house prices reflects
: }/ u( G& j& sboth a cyclical downturn and a return of house prices
  _' X/ s: f/ E" r( w7 Vto fundamentally justified levels.
4 e0 f! J! J2 |We consider “overbuilding” of two forms: “demanddriven”
4 d8 T: @! s% _6 Y# M4 fwhere homebuyers buy up too many houses and
, g# [7 }; U8 f7 k) v' l3 j+ Tthat this demand cannot be sustained; and “supply-driven”
: L! i* G% Y# L$ A4 Qwhere builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
- l! U3 S. @6 R* d+ |7 P9 ]the 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
1 C& f- k$ N# D1 {% ]+ mremain choppy and new residential construction will be
3 x6 k4 z: F+ \6 c* adampened, owing to this structural weakness. Construction
' ]! r5 L' g0 Bis now undershooting fundamentals and we expect this
& E# z0 x! _2 O- ?5 E. M' @0 q+ a/ Qto persist over 2009 to 2011. We anticipate that nationwide
: F" s# C- b& S- Yresidential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
' {  {; B3 ^# ~' }; e* }- nin the fourth quarter.
1 S6 O6 J( G/ a! H0 \' p8 vTo quantify the degree of overpricing and overbuilding,
* v* z$ @4 o; Bwe first develop an empirical model, based on long-run
- _& O4 x0 U) L/ _2 t8 vfundamentals of house prices and housing starts in each
province. Affordability is the key concept behind home
# ?2 I9 d1 L) e$ s& ]+ v) Xvalues since house prices should track incomes over the
long-run. Since homebuilders build to meet demand, we
regard housing prices and household formation as the drivers
8 R- u# ?- l+ C* |) Vof residential construction.
: u& T* w* f( iTo examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
7 {/ {" P" a7 `1 I; Bfundamental-justified level by about 12%. Although new
: j, G, d( O1 |1 M7 v1 P1 dunits were being absorbed, homebuyers simply bought too
8 X% l- M! H5 V' y! x! lmany houses at prices that exceeded fundamentals.
& `: ~% K. f2 G0 m4 J9 FRegionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
! {; _7 h$ F+ l4 f# \7 k5 }9 zalready witnessing surges in their unsold new homes at the
very time that the resale market has swung into strong
  L& W9 k3 q7 B* _! Z& Zbuyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
0 O; N6 A( w0 a1 [( f4 ?weakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
7 c. m9 {* e. }* u! F1 w& astrange accumulation of unabsorbed multiples on l’Île de
Montréal – but recent building has been relatively balanced,
# W: `) F+ v& Dgiven the province’s history of under-building and low ownership
rates. While Ontario homebuilding will reel from a
8 @& P% i! R) @6 j2 O( z* a/ kcyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
8 I, u0 Q" |; }/ C  c0 Bconstruction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
6 p0 }6 L0 _0 I% w1 Vspike severely – particularly in Vancouver. However, while
0 z. v5 q# x" x  ^9 p. hresidential 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
, D  ]0 D- @+ a: Z3 J9 Myears, which, along with improvements in affordability,
  ?0 m& D5 l( X6 z; ^will alleviate some of the pressure from overbuilding.
9 M5 G$ B5 V- S( t/ ROVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
7 d+ K/ P9 b0 b  O; i, |) {416-982-8063
Pascal Gauthier, Economist
: H; V# S) w" @416-944-5730

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

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