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
, p' _! F% a' ?1 w3 wunsustainable levels of building. Our view is that house
prices exceeded the value of housing that was justified by
. ^; P- x; X' D1 ?& n4 n4 o( Ufundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
; J& A: h* |: `4 @: o4 ^5 i12%, an excess that was exaggerated in the past
three years.
By “overpricing” we mean that prices detached from
/ Z7 {& V4 C5 ?* A) Utheir fundamentals, as witnessed by a steep erosion of
5 [( _. @  i" ?( ^# Laffordability. The current unwinding of house prices reflects
both a cyclical downturn and a return of house prices
1 _( B' A* Q4 _# |to fundamentally justified levels.
, l5 n# t% D. O& P! P4 lWe consider “overbuilding” of two forms: “demanddriven”
: c3 ^5 g1 K0 o  R8 b3 f- i  ~5 Mwhere homebuyers buy up too many houses and
+ {* ^9 M: K" ]8 S$ g0 [. sthat 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
8 L5 n5 ~/ x6 e8 s, F“overbuilding” was mainly of the first type, where
4 A' t$ a4 J6 uhomebuyers pushed homebuilding to an unsustainable pitch
' P3 s0 v1 R% J1 \7 T+ p7 vthat is now being rapidly reined in.
) W" l2 `7 w% r+ e/ J4 ?) TWhile 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
# `5 d2 T) ^* cfrom the cyclical downturn, house price growth will
% [$ n9 I# x& Z% \; eremain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
( D, r! q, e! A: t# ]. j" P4 Ito 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
7 z! i; y  V2 r, J. zin the fourth quarter.
, l" n: i( ?5 ]& W; O8 W$ U! GTo quantify the degree of overpricing and overbuilding,
! F# U" l. b( iwe 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
long-run. Since homebuilders build to meet demand, we
9 N( i3 g  g7 Q1 @3 Z$ I2 yregard housing prices and household formation as the drivers
6 n3 D# |. p/ @' i1 q# n1 b; B2 }of residential construction.
( a: w/ j8 X. ]To examine the degree of overbuilding, we employ a
# U/ e" J$ \) C( B“counter-factual,” asking what level of residential construction
5 e/ j; u* T' P$ S6 s1 G5 kwould have occurred if housing had been priced
" a7 u5 |, I9 P& j& Xoptimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
( m2 _; J9 H  n) V5 Nmany houses at prices that exceeded fundamentals.
; H/ S* o# ^: ^/ C! O+ yRegionally, we see the greatest strains on the Prairies,
9 d' b* R- K/ s- ^where housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
8 C2 u) ^& L' A0 N5 C+ Calready witnessing surges in their unsold new homes at the
& l0 X6 U& u. l2 ]! A+ [very time that the resale market has swung into strong
buyers’ territory. Homebuilding in the Atlantic provinces
6 K/ F% q% Z3 }0 ihas been relatively balanced but, while not plagued by structural
% X! Q3 m! E/ v/ D- Y) ]; g, rweakness, 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,
given the province’s history of under-building and low ownership
8 e/ |! @( j6 x+ S, B$ p- D$ Zrates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
; X6 E% F! T7 O9 s; Rlimited – with the important exception of the Toronto
) S; z2 k: W$ x1 Y4 m! }condo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
construction mean that record numbers of condos will
* D  T) G: b0 ]3 |+ a+ g1 Greach completion during 2009. If absorption rates fall, as
! p" u% A! z. }, s" Q( N: ?cyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
1 ^* k' y+ c6 T+ xresidential construction in B.C. will definitely droop, we
anticipate that the West Coast will continue to benefit from
2 u/ G6 P1 n3 `0 {- E3 D8 Linter-provincial and international migration over the coming
% m1 Y) ~& K4 P2 A  Myears, which, along with improvements in affordability,
# s) I. `% g* c. D$ F7 [will alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
/ M' m, q0 G2 B% X9 hGrant Bishop, Economist
416-982-8063
, H$ F1 s$ W/ R! o6 W8 ]9 NPascal Gauthier, Economist
1 L0 J3 g1 I$ g; E8 K( t0 P416-944-5730
! d9 k4 c# K1 j7 H
) ]- h4 U7 k& V: v7 t7 Q* nhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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