TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
, R  K+ I2 b0 hfrom 2002 to 2008, unsustainable price increases drove
) _) P- f) T. O! g' C3 w0 _6 P- Tunsustainable levels of building. Our view is that house
prices exceeded the value of housing that was justified by
  C" o0 N8 L3 N$ N1 R8 T% Wfundamentals by approximately 9% nationwide. This
% R; D3 L' N' Roverpricing compelled a level of residential construction
1 ^4 a! q$ H/ j/ {that exceeded its fundamental-justified level by approximately
. X; J7 E. f* `; u5 I) R12%, an excess that was exaggerated in the past
$ ]! V7 S3 D* w7 p. I, Uthree years.
  D. A2 n/ y9 HBy “overpricing” we mean that prices detached from
( ~; |7 _; R1 F& n3 h1 V: A- W7 ^7 g# dtheir fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
both a cyclical downturn and a return of house prices
" K! d+ F% V8 @! V3 fto fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
. Z; B9 Z& q, A& w* `where homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
% z, e; O# i' `' W3 V; U3 G7 q. kthere is evidence of both types, we contend that Canada’s
8 S: {7 @$ L  Z/ G, g“overbuilding” was mainly of the first type, where
& h* y- N- n7 R4 K# W+ Z, Rhomebuyers pushed homebuilding to an unsustainable pitch
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
2 y0 D9 a, Q1 G9 G! wmeans 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
  s& f/ l: \) F  z& P5 d2 _6 cdampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
0 G# t9 n4 P6 V, S/ k; [to persist over 2009 to 2011. We anticipate that nationwide
residential construction will fall further to around
. I$ X8 @, {. Y125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
To quantify the degree of overpricing and overbuilding,
& s0 g3 {$ i" ^8 g8 q/ M( Awe first develop an empirical model, based on long-run
+ t4 X7 H/ u- _: y/ k5 n/ W7 S5 M8 Ufundamentals of house prices and housing starts in each
! U7 R0 l/ I1 m/ dprovince. Affordability is the key concept behind home
6 u1 _  c2 c4 H2 D) [7 T8 wvalues since house prices should track incomes over the
/ y# S3 z8 m2 w" zlong-run. Since homebuilders build to meet demand, we
/ A, n  w4 M+ @# a4 mregard housing prices and household formation as the drivers
& ?: Z$ R  e) P6 X9 @of residential construction.
$ ]* g  J' m# Q" r2 c; Z0 u2 V$ h. YTo examine the degree of overbuilding, we employ a
0 G/ ]! ]+ P9 `/ G, p% {“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
* m) I+ [5 w5 u* f+ Y+ }units were being absorbed, homebuyers simply bought too
9 k- j7 a3 u& u  `! m# n7 smany houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
. a7 l9 s; ^$ t/ V" Zwhere housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
8 b* b) ]- F9 `- g2 v# i6 Z# q5 n/ Ialready witnessing surges in their unsold new homes at the
  [, j2 i- U3 v4 Dvery time that the resale market has swung into strong
buyers’ territory. Homebuilding in the Atlantic provinces
  v6 i, w$ i0 x1 m5 Jhas been relatively balanced but, while not plagued by structural
. o# s# u& `  Vweakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
strange accumulation of unabsorbed multiples on l’Île de
1 O: S. E# E3 p4 |( X# E- yMontréal – but recent building has been relatively balanced,
4 b6 p- g8 V; q; ?given the province’s history of under-building and low ownership
rates. While Ontario homebuilding will reel from a
* U, h$ c# Y6 Q8 r% v, tcyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
& U' T3 z6 D; e7 u5 o; U% Lhigh 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
spike severely – particularly in Vancouver. However, while
residential 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
years, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
- f$ X+ J3 }2 h7 K. BOVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
$ E( ?' z9 A) w* X6 O0 T9 F* X& S$ y416-982-8063
Pascal Gauthier, Economist
416-944-5730
2 e6 A. t2 N* d
. T, h, t1 X  A* bhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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