TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
0 g* h$ z- B" ffrom 2002 to 2008, unsustainable price increases drove
unsustainable levels of building. Our view is that house
. w3 g) w* T; w! T8 D3 Rprices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
8 M. M' z& l% D2 xoverpricing compelled a level of residential construction
5 B; Y; K# d2 S, L" Zthat exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
( A( ~5 z* {8 y: W$ Tthree years.
By “overpricing” we mean that prices detached from
$ g. i: w5 _4 w% ?  q0 K- c# atheir fundamentals, as witnessed by a steep erosion of
* \* ^3 i0 r0 j1 T( w7 L$ O0 daffordability. The current unwinding of house prices reflects
both a cyclical downturn and a return of house prices
to fundamentally justified levels.
1 e1 X0 T5 a3 Q7 w* u9 O: z: EWe consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
, N& _' \0 P9 d" }* Z) 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
6 l- h, s4 ]) J# z& dhomebuyers pushed homebuilding to an unsustainable pitch
7 r5 E3 N4 P3 T1 p3 g& sthat is now being rapidly reined in.
: _; ^+ n1 B) n+ @: Y) X" yWhile most markets won’t face U.S.-style overhangs,
& _* }- a5 _( e: c# s$ g! Ethe construction of too many new homes over the boom
3 {$ I/ ^% P. s4 x7 umeans 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
dampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
; S9 V" c, p# C) R' xto persist over 2009 to 2011. We anticipate that nationwide
# U5 }/ @6 L. D' c3 E/ \/ aresidential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
1 j2 I2 H6 x. L9 q! w% ^9 `% bin the fourth quarter.
To quantify the degree of overpricing and overbuilding,
we first develop an empirical model, based on long-run
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
1 G6 }# L0 H% Qlong-run. Since homebuilders build to meet demand, we
- S) O2 _" Z) ~! O: bregard housing prices and household formation as the drivers
of residential construction.
% D5 p0 o1 F7 _; ]To examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
$ x) t2 `9 j! h# Y" Mwould have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
7 j6 G) m" B- E5 b: ~" @2 qmany houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
! ~! T# w, T' z; p8 t' o5 Jwhere housing demand will further contract under waning
$ e( b. r; k9 @  g6 a! Ppopulation inflows. Saskatoon, Calgary and Edmonton are
, f8 m: _9 W  \( ?" Qalready witnessing surges in their unsold new homes at the
* F, N8 [# w. |6 c: ]8 Every 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
% K" ~) f$ Z0 q' {1 sweakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
strange accumulation of unabsorbed multiples on l’Île de
- w0 O) S- r, c; f% eMontréal – but recent building has been relatively balanced,
( }% z4 R% d% H2 X- ngiven the province’s history of under-building and low ownership
rates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
1 S, v% v$ i0 }- o# M+ R5 Xcondo market. Both in Toronto and Vancouver, historically
- R* \- r+ w! phigh levels of apartment-style units presently under
construction mean that record numbers of condos will
7 U6 T9 P& [! C7 ureach completion during 2009. If absorption rates fall, as
2 S7 S5 @; z2 v* x) f1 hcyclical factors would indicate, condo inventories could
; k0 J1 V# r! Xspike severely – particularly in Vancouver. However, while
; P2 r3 Q! H1 ^# s7 u4 Eresidential construction in B.C. will definitely droop, we
anticipate that the West Coast will continue to benefit from
. R: _% F' w3 r8 u1 Ainter-provincial and international migration over the coming
* x+ j! l* W' a* w( wyears, which, along with improvements in affordability,
  i) x! l4 q, o6 `: \will alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
" U$ C. F7 H! b1 l& yMARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
- `, [) t0 d  q) F416-982-8063
' _- t" S" z% x, RPascal Gauthier, Economist
, L7 N% U3 c: r9 ?416-944-5730
, d: t/ j8 |8 {% K* W
7 y8 g+ g" {( j% a6 }+ `/ Z. dhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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