TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
- E/ f! v- X7 e/ {2 a" yfrom 2002 to 2008, unsustainable price increases drove
unsustainable levels of building. Our view is that house
3 K( @- }4 p3 D( K( w& wprices exceeded the value of housing that was justified by
% a1 g. f' ~+ s+ C! \fundamentals by approximately 9% nationwide. This
& R) W9 f( @' loverpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
# w/ E: ]$ m, g; ~0 W* a* |/ ~7 Hthree years.
By “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
2 f3 }  F$ \0 r4 j/ U, naffordability. The current unwinding of house prices reflects
both a cyclical downturn and a return of house prices
to fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
% s2 o* ?& m6 n$ P$ f“overbuilding” was mainly of the first type, where
* y$ n7 c* g1 ~4 \homebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
  G% i7 {4 Y7 @5 jWhile most markets won’t face U.S.-style overhangs,
5 y) C! G# p3 Xthe construction of too many new homes over the boom
2 Q0 s2 J9 U1 g* E1 @means a deepened slump. This overbuilding will likely weigh
on markets over the next few years. Even as Canada recovers
8 X4 [' i( S; Z! t/ ?/ Afrom the cyclical downturn, house price growth will
0 p- T9 x$ ?+ P9 B& ?, aremain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
residential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
. o; s) K+ c5 d1 [5 ZTo quantify the degree of overpricing and overbuilding,
% T4 n( n* O. w/ i$ Wwe first develop an empirical model, based on long-run
7 `, c/ a; J( f4 J6 ~7 I5 K. x0 Sfundamentals of house prices and housing starts in each
province. Affordability is the key concept behind home
' }/ f( {8 d2 ?3 W. t: Cvalues since house prices should track incomes over the
long-run. Since homebuilders build to meet demand, we
0 }% B# I* H& g$ X/ Fregard housing prices and household formation as the drivers
of residential construction.
To examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
# J+ C& I+ C; s+ D4 c; Boptimally. We find that actual homebuilding exceeded this
% z5 |7 }7 [. i8 I% l6 }- |fundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
/ P$ [# x% v+ O5 ~/ Fmany houses at prices that exceeded fundamentals.
8 Y9 U+ G% W) _, WRegionally, we see the greatest strains on the Prairies,
. h5 i' }8 P) S$ L/ M6 k+ Bwhere housing demand will further contract under waning
5 V/ {8 ^/ A# W! Zpopulation inflows. Saskatoon, Calgary and Edmonton are
( M3 e: d5 `2 N! C/ }already witnessing surges in their unsold new homes at the
very 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
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
" F# \% h7 I: jMontréal – but recent building has been relatively balanced,
given 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
& j0 d2 Q( Q6 ?* A4 Climited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
: A% Q% `# X0 f1 Ihigh levels of apartment-style units presently under
) w/ ^. v0 B0 q& V9 w% Uconstruction mean that record numbers of condos will
9 i' ~. m/ m7 Lreach completion during 2009. If absorption rates fall, as
0 U. m% ^3 e, ?2 b) R- xcyclical factors would indicate, condo inventories could
4 T' ~# K8 [% F5 c3 K+ ?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
1 c0 }" F  {: T* B, @# M+ C6 Binter-provincial and international migration over the coming
years, which, along with improvements in affordability,
. N1 {0 V, ]' r% q- ~6 jwill alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
: U. N' H1 x5 ]5 F# e& V) |MARKET RETURNS TO FUNDAMENTALS
  g9 h1 Q3 A0 u- SGrant Bishop, Economist
3 s* O  ~, @; z& ^416-982-8063
- t. X# {( j7 l+ j2 D: e* fPascal Gauthier, Economist
416-944-5730

7 x4 w1 s) r3 N; w' b7 uhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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