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
unsustainable levels of building. Our view is that house
prices exceeded the value of housing that was justified by
3 b' Z0 k, t- [fundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
; L* T) F- k3 R9 R& f- T12%, an excess that was exaggerated in the past
2 |* o  F5 `& ^three years.
5 o# u. Q& J. z+ rBy “overpricing” we mean that prices detached from
' k. A+ F, P2 B$ [% htheir fundamentals, as witnessed by a steep erosion of
. p* ~$ I' ?( g; d1 P; U9 aaffordability. The current unwinding of house prices reflects
9 a& u+ n5 ]) q4 T, N% s" t# Uboth a cyclical downturn and a return of house prices
to fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
5 B  A. l2 j  b# L1 {6 awhere homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
9 P3 e. m$ ]" O$ ^where builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
4 D/ c2 z+ Y- [: K$ E1 \" b“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
8 Y2 }) s* {$ zthat is now being rapidly reined in.
& C! }3 j1 v) u( m' vWhile 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
5 t5 c, ^+ H2 [# ?1 R, m" h" Xon markets over the next few years. Even as Canada recovers
* `* ^! k) N, V+ `from the cyclical downturn, house price growth will
remain choppy and new residential construction will be
! I7 [" R9 O) F- E- ]dampened, owing to this structural weakness. Construction
/ \9 B' ]" _' Q5 J, x- @is now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
0 q7 A  f1 B5 n. t0 Q( gresidential construction will fall further to around
- G7 k2 Z# [- C0 U# |7 ~% ?125,000 starts over 2009 with a trough around 115,000 units
in 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
- e) ]  E$ h" t2 E( }% c# xprovince. Affordability is the key concept behind home
0 q: @9 `  }6 q$ i* ]values since house prices should track incomes over the
# C3 U. |4 x/ V8 q' Ulong-run. Since homebuilders build to meet demand, we
1 D& s& X5 m* z3 o- D- ]4 \* O4 h- jregard housing prices and household formation as the drivers
of residential construction.
To examine the degree of overbuilding, we employ a
) l7 s$ N6 ?+ w, \“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
% H; Y6 m# g6 T! F- j) poptimally. We find that actual homebuilding exceeded this
" m& n5 p& `$ A2 G  u; Mfundamental-justified level by about 12%. Although new
  y; |8 ^) N" h2 u7 `- G4 ~& nunits were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
8 F& B0 c: Z4 E& b5 R7 l( Nalready witnessing surges in their unsold new homes at the
3 v$ \1 D* c- y( t& e" ^6 `7 ?$ w7 Wvery time that the resale market has swung into strong
) t$ |( ?' B" X( v2 Qbuyers’ territory. Homebuilding in the Atlantic provinces
. y8 p0 x. F" bhas been relatively balanced but, while not plagued by structural
& l2 V. D- @2 g3 {0 D. xweakness, 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,
% W# @0 K( r9 c/ Q, G& tgiven the province’s history of under-building and low ownership
rates. While Ontario homebuilding will reel from a
$ }4 p; K6 J, Q1 ^cyclical 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
* [5 P( j1 z3 f  s$ i; m/ e; Jconstruction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
$ L; v# q. K1 U! r2 |5 k  R/ y( vcyclical 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.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
Pascal Gauthier, Economist
1 U+ m: p" M) f. C416-944-5730
5 j" ^2 T4 {3 W& a9 a( Q
) ?8 f& |: L: B6 Fhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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