TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
+ ]) M+ E! Q( K4 x9 s8 S$ S4 H" ^from 2002 to 2008, unsustainable price increases drove
% `6 {6 L/ }' J4 @unsustainable levels of building. Our view is that house
% Y1 A' e; [( y" e) I+ Mprices exceeded the value of housing that was justified by
3 l$ W, q4 f) b0 z% V0 M( h: Jfundamentals by approximately 9% nationwide. This
8 v2 _: _" w* Y( n: Hoverpricing compelled a level of residential construction
% o5 |0 f! S; a5 W7 `$ ~! x% jthat 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
% ^* t4 ?0 J- z% D: fboth a cyclical downturn and a return of house prices
8 M+ n/ G5 z, v8 ]/ v3 O! bto 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
4 t3 b' N) o7 I) g2 rthere is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
& }" S7 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
means a deepened slump. This overbuilding will likely weigh
" p2 ^8 e3 o" ^. |on markets over the next few years. Even as Canada recovers
from the cyclical downturn, house price growth will
$ F0 L2 g& t, v/ S; \% a7 S1 Tremain choppy and new residential construction will be
0 V9 \* [# U& F7 f+ kdampened, owing to this structural weakness. Construction
+ v* n8 g% Q# g- r3 ^5 D3 Q: Bis now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
7 Q, N8 m/ m& U5 {" U- ^" iresidential construction will fall further to around
, D: i8 O. d/ X) {4 Q! H: V125,000 starts over 2009 with a trough around 115,000 units
" [! g  n5 p* J: Jin 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
2 w* h6 D  @- e9 Wvalues since house prices should track incomes over the
long-run. Since homebuilders build to meet demand, we
* Q/ `& \4 E1 A% r/ a  iregard housing prices and household formation as the drivers
; R7 D1 }8 o2 |1 X/ f4 H: Uof residential construction.
To examine the degree of overbuilding, we employ a
0 u$ E- Z1 }' W' _( n“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
; _- M% c1 p: y4 B$ f* |# G$ eoptimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
9 n2 {1 s7 `" m! R8 Funits were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
$ W6 R4 B; T6 |5 mwhere housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
, s* q3 y6 I# X0 Galready witnessing surges in their unsold new homes at the
very time that the resale market has swung into strong
0 X% y$ M' }; D: t5 U+ tbuyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
( N) m4 G: H- aweakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
strange accumulation of unabsorbed multiples on l’Île de
: L, I8 s9 W6 X8 cMontréal – 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
limited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
5 @. Y6 B4 l7 ]$ `; b9 l' [high 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
& e! {% g2 D3 a6 b2 Uyears, which, along with improvements in affordability,
$ }6 k/ ~% K4 xwill alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
) o5 q( k+ V% K! XMARKET RETURNS TO FUNDAMENTALS
" T2 f' _4 x) T, T( dGrant Bishop, Economist
416-982-8063
Pascal Gauthier, Economist
/ s& u3 t9 K- g) z4 g- P416-944-5730
; |7 Q) e4 ~7 b  e# M
" D0 f% Q& V6 Y( q- a! [9 Hhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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