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
0 m$ w: D& f% a* H( u% o6 W4 Iunsustainable levels of building. Our view is that house
prices exceeded the value of housing that was justified by
2 P* k+ Q4 \5 ]5 O; [' gfundamentals by approximately 9% nationwide. This
$ q/ O  p+ q9 y6 e; foverpricing compelled a level of residential construction
# q/ ^( h" w: X. Fthat exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
0 C8 r) o) ?2 ~6 u; k* ?9 mthree years.
( p  }! @. F. H( |! kBy “overpricing” we mean that prices detached from
+ ?1 T; c) \* W; [( }9 qtheir fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
! [. A  O2 O- v8 j5 E& {+ mboth 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
* t$ ]; ]8 C/ L- q. A4 v' bthere is evidence of both types, we contend that Canada’s
+ C% }* u  K: k“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
5 S! L9 u! G. Cthat is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
/ e1 a7 U: w, Q. j4 Gthe construction of too many new homes over the boom
* M7 l5 u, o& F: \% ^: f1 imeans a deepened slump. This overbuilding will likely weigh
1 I. u( `/ W9 }* P. f& Von markets over the next few years. Even as Canada recovers
8 l7 [% ^! Z$ H* g1 T8 vfrom the cyclical downturn, house price growth will
0 L- b; {! p0 S+ T( n& C: z3 d! Dremain choppy and new residential construction will be
1 S9 X1 x! G% }* Edampened, owing to this structural weakness. Construction
+ j" x$ O0 I0 h" F  N0 Lis now undershooting fundamentals and we expect this
; i9 _4 E% b2 Fto persist over 2009 to 2011. We anticipate that nationwide
residential construction will fall further to around
, k2 s' H" w; A7 ?! l9 s7 o6 b125,000 starts over 2009 with a trough around 115,000 units
# [1 t: c4 m( v" |) @( @' \- [in the fourth quarter.
To quantify the degree of overpricing and overbuilding,
7 k+ H, U! h9 Z$ k9 W6 ]we first develop an empirical model, based on long-run
* Q5 Y4 u* d- d# Zfundamentals 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
regard housing prices and household formation as the drivers
of residential construction.
0 ]* l* W5 f: w; V" m: BTo examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
- j7 \- z/ f% D( L0 m0 owould have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
- T: u; N$ \; u3 i: U$ P$ e1 @units were being absorbed, homebuyers simply bought too
  ]; E5 |9 C7 `. K, H% Bmany houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
+ N" G+ e/ g5 R8 k4 ^population inflows. Saskatoon, Calgary and Edmonton are
( E! W, K1 G. v9 `6 z. `already witnessing surges in their unsold new homes at the
very time that the resale market has swung into strong
( |4 M2 [: Z  }, |buyers’ territory. Homebuilding in the Atlantic provinces
2 |5 M: A! S/ D6 ~has been relatively balanced but, while not plagued by structural
weakness, will be singed by the downturn nonetheless.
: M+ w; {% }  g! m& d& K$ o/ n# d& \Québec shows signs of strain – especially given the
strange accumulation of unabsorbed multiples on l’Île de
. f( k; i1 i1 g. s  GMontréal – but recent building has been relatively balanced,
( C: q- Q; L! ugiven the province’s history of under-building and low ownership
rates. While Ontario homebuilding will reel from a
: R* |/ U( V8 M! x9 }1 Ocyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
! {5 m4 c! i% o2 N* T- Lhigh levels of apartment-style units presently under
2 J8 M3 Q& j$ q) Kconstruction mean that record numbers of condos will
' s  B1 R; w/ o3 Yreach completion during 2009. If absorption rates fall, as
2 C' ]  V6 e9 x  i! K9 o1 ccyclical factors would indicate, condo inventories could
- k, H& L6 X0 |/ L7 `/ mspike 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
years, which, along with improvements in affordability,
' L! T0 M+ P$ c8 p$ \will alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
Pascal Gauthier, Economist
- j, c7 k2 d9 v( L. R4 J416-944-5730

1 s1 c# ^; n! Mhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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