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
* T) _1 |; u* l8 n. y+ ]2 L, G3 v# r9 funsustainable levels of building. Our view is that house
2 |+ ~: r) X, R6 F* P( Aprices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
7 V, O& ^. ]( a2 f# t2 uoverpricing 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.
6 o: I5 [2 e/ |* s. ]5 n! a8 ?5 o+ qBy “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
1 i# d1 F, K7 h4 {3 f, B- L1 M  c6 Paffordability. The current unwinding of house prices reflects
both a cyclical downturn and a return of house prices
to fundamentally justified levels.
- R  }2 [- i* CWe consider “overbuilding” of two forms: “demanddriven”
: c! Z# t7 Y. ?+ ^# v! Z9 cwhere homebuyers buy up too many houses and
" W1 X: Q& n  R' f: E, U" gthat this demand cannot be sustained; and “supply-driven”
! R) f. F+ H9 o1 d, Ywhere builders accumulate excessive inventories. Although
* e$ i/ N) Y1 N7 a5 w4 f% Dthere is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
9 m5 O8 S5 {% @While most markets won’t face U.S.-style overhangs,
' T3 o. E& M0 @4 G3 a2 b+ Tthe construction of too many new homes over the boom
; l4 c) S# e) f" m' T9 }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
remain 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
1 e+ z1 b6 x- Cin the fourth quarter.
' I$ R) G% c4 M8 WTo quantify the degree of overpricing and overbuilding,
; t9 J" P4 w6 }$ i: ]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
& u" E. k) ^6 O# x) Hlong-run. Since homebuilders build to meet demand, we
0 I  `, g  S! |$ x5 x$ P0 O8 rregard housing prices and household formation as the drivers
of residential construction.
To examine the degree of overbuilding, we employ a
' V/ k. b) T% }“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
7 t* r) r. M  O( w4 funits were being absorbed, homebuyers simply bought too
9 ^! e# R% e  u  @7 g2 imany houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
1 J7 U5 ?. V0 d7 H( a  L! pwhere housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
5 A3 v/ k( N% q5 B2 palready witnessing surges in their unsold new homes at the
: P- z2 \, D6 E; D/ yvery time that the resale market has swung into strong
buyers’ territory. Homebuilding in the Atlantic provinces
! S  X: K2 |. ehas been relatively balanced but, while not plagued by structural
weakness, will be singed by the downturn nonetheless.
7 n+ d( |9 V% o3 v% s! J6 F2 _/ jQuébec shows signs of strain – especially given the
strange accumulation of unabsorbed multiples on l’Île de
: H* K5 P: w5 y0 z' K4 RMontréal – 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
5 _# e/ x( D* ^5 \6 ?: s! N* e6 rcyclical downturn, the degree of structural weakness appears
& _3 T8 M% u; N6 Dlimited – with the important exception of the Toronto
  S& P# ~! ^* ucondo market. Both in Toronto and Vancouver, historically
# K* c7 Y% ]2 t1 shigh levels of apartment-style units presently under
construction mean that record numbers of condos will
! |' _! X2 g/ @7 D8 X; D2 h% ureach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
8 V  }; R) C- E' _/ g7 [spike severely – particularly in Vancouver. However, while
2 _2 T0 N  O% i0 ^+ r$ J: H9 Aresidential 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.
! p# \) Z6 x" l# T8 O: [9 M) J7 jOVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
$ @" I# A! ~( h) @Grant Bishop, Economist
416-982-8063
5 S$ n* S1 ~, j6 a6 Q1 APascal Gauthier, Economist
$ j$ E+ S1 g( o416-944-5730

# c' b0 A& K' e  q+ S% jhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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