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
unsustainable levels of building. Our view is that house
+ S& [/ t5 i& ^+ s0 Jprices exceeded the value of housing that was justified by
7 f7 y) t! T. k! Mfundamentals by approximately 9% nationwide. This
# w( O7 ]: \" S9 woverpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
+ [# v: u; w: B# ]+ V12%, an excess that was exaggerated in the past
3 T# p% X8 y. j" o/ A. n) C' Qthree years.
% u  C- V7 ~# d: n+ t3 O7 hBy “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
+ {- `5 _  s. V8 qboth a cyclical downturn and a return of house prices
5 X/ s& o3 m" A" }to fundamentally justified levels.
8 J$ O: [9 `: O/ z$ j9 oWe consider “overbuilding” of two forms: “demanddriven”
" @4 }' o; S. A9 Dwhere homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
. o9 \) V* Y: ~5 V& Qthere 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
+ q% h+ O5 B' Z2 t2 kthat is now being rapidly reined in.
$ K! g3 k: E/ q* J3 LWhile 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
4 B  B& k. o3 f; I1 Afrom the cyclical downturn, house price growth will
remain choppy and new residential construction will be
$ n# A% ?+ h  M4 }8 J: }5 Q1 h: s  odampened, owing to this structural weakness. Construction
. O4 h6 O3 Y* U8 x6 [is now undershooting fundamentals and we expect this
$ V$ D; j' \: O3 V. zto persist over 2009 to 2011. We anticipate that nationwide
residential construction will fall further to around
1 W4 W2 v# v" ~/ l9 s125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
3 [! a5 X: Q6 c, f4 V  ^) aTo 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
values since house prices should track incomes over the
" i3 j0 l) D  a4 D; A. d3 |long-run. Since homebuilders build to meet demand, we
3 |/ V3 n8 D! X% O. {; a- {7 S) M9 S+ Uregard housing prices and household formation as the drivers
5 x6 |5 S+ d4 _4 V) D- Y% Nof residential construction.
0 L9 Q+ u3 V4 t! F5 K! uTo examine the degree of overbuilding, we employ a
% ^2 S; r/ V) Z6 D“counter-factual,” asking what level of residential construction
: Q2 S9 p7 ~6 F) c& nwould have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
- c! O9 V* }5 J& eunits were being absorbed, homebuyers simply bought too
* r6 U' A* z% d1 h& W+ c; F  Qmany houses at prices that exceeded fundamentals.
5 X2 n5 C) `# V8 y7 fRegionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
5 [) V) ]; l( V, t. E* zalready witnessing surges in their unsold new homes at the
very time that the resale market has swung into strong
buyers’ territory. Homebuilding in the Atlantic provinces
8 g9 X% L/ ~3 r2 j$ Ahas been relatively balanced but, while not plagued by structural
  \; J8 m2 ]1 L. ^weakness, will be singed by the downturn nonetheless.
4 u5 [/ B4 c& b& k$ aQuébec shows signs of strain – especially given the
0 a5 S& E/ T6 C- kstrange accumulation of unabsorbed multiples on l’Île de
1 `. g% T3 \2 o$ IMontréal – 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
. C5 h0 F, P; `* w, ulimited – with the important exception of the Toronto
% O+ H* D" w" u) R6 Scondo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
: _1 s+ w- ~& k/ |; Econstruction 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
- b2 b5 c2 ?; P0 `inter-provincial and international migration over the coming
6 V, P8 O, C) _; Y/ Kyears, which, along with improvements in affordability,
9 m% `, l) l2 D/ F- wwill alleviate some of the pressure from overbuilding.
0 X7 q3 q  @5 D7 N9 lOVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
/ W+ A0 X0 m8 ?; V7 h- nGrant Bishop, Economist
416-982-8063
Pascal Gauthier, Economist
$ n+ O! v9 a2 i/ {7 n+ v416-944-5730

6 e& }8 }  O0 Thttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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