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
5 G5 K3 Q  x0 l$ Yunsustainable levels of building. Our view is that house
prices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
three years.
By “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
  T1 V9 o) _5 t5 Oboth a cyclical downturn and a return of house prices
to fundamentally justified levels.
" `; Q# F& _+ D  V2 o+ KWe consider “overbuilding” of two forms: “demanddriven”
( {. P6 E2 l; B$ R( Hwhere homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
! Z  e  X) w3 j) f/ y( k; Othere is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
2 m, R' q& p( K# y( q9 dhomebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
: V7 c7 r/ v: t$ y# }; J# N- dWhile 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
on markets over the next few years. Even as Canada recovers
from the cyclical downturn, house price growth will
+ N4 Y  V% t1 Nremain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
5 X2 z) g1 {  G% Zis now undershooting fundamentals and we expect this
0 d2 v, R0 ^0 A9 @to persist over 2009 to 2011. We anticipate that nationwide
, I  }& I9 T) x* U7 wresidential construction will fall further to around
8 L  x( N9 R* h5 R+ G125,000 starts over 2009 with a trough around 115,000 units
8 }/ t1 [0 |9 I, M/ O4 U& p( Min the fourth quarter.
* `$ U! r% |0 j, a/ U2 J) v& DTo quantify the degree of overpricing and overbuilding,
. r& A# c0 |: f% Z7 T3 v1 _we first develop an empirical model, based on long-run
  G9 n  f0 r4 B4 ^fundamentals of house prices and housing starts in each
province. Affordability is the key concept behind home
+ M9 E4 O( `2 q6 ]9 A8 Ovalues 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
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
0 z, j$ W9 f! s0 Y4 E& u  joptimally. We find that actual homebuilding exceeded this
. n' k' y1 Z7 |! @/ A, pfundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
  p$ l9 G. ?, h9 u/ {4 j# fwhere housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
' P1 S0 k) P+ E. vvery time that the resale market has swung into strong
" L% m" ^- y( |$ O4 [0 K  Z- ^' f( mbuyers’ territory. Homebuilding in the Atlantic provinces
+ t) L9 O  r) g0 _has been relatively balanced but, while not plagued by structural
# G, F6 W# h* z1 w$ l  W  ?- gweakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
3 M) F3 v( }7 R! i: L. R9 P( e; ^strange accumulation of unabsorbed multiples on l’Île de
Montréal – but recent building has been relatively balanced,
% u5 M$ O7 {: q0 a8 N; vgiven the province’s history of under-building and low ownership
rates. While Ontario homebuilding will reel from a
$ M$ S" c: s( m1 B' ^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
1 c0 l1 m3 u1 L3 f% econstruction mean that record numbers of condos will
3 ?, U/ f# |5 p) l; O7 r6 A0 N+ o, ereach completion during 2009. If absorption rates fall, as
8 w1 h4 y' S& q* v' H6 rcyclical factors would indicate, condo inventories could
! B2 }! L3 D0 H9 O3 g8 b0 xspike severely – particularly in Vancouver. However, while
residential construction in B.C. will definitely droop, we
9 t8 C8 b6 a1 B: Uanticipate that the West Coast will continue to benefit from
inter-provincial and international migration over the coming
1 T+ a' c1 {  {5 N, W# |. myears, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
9 x' d; L+ n* n" H' |# [& dMARKET RETURNS TO FUNDAMENTALS
" m3 l4 V4 V& d8 j3 [# oGrant Bishop, Economist
416-982-8063
Pascal Gauthier, Economist
416-944-5730

# N# c9 Y( n* y  a# W! H( qhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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