TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
1 T4 a& h) W+ q4 |/ |# vfrom 2002 to 2008, unsustainable price increases drove
6 i) f0 D0 d) _$ D  yunsustainable levels of building. Our view is that house
prices exceeded the value of housing that was justified by
6 K6 {8 K- V1 S  B$ hfundamentals by approximately 9% nationwide. This
' R* Z8 Y" }9 ?+ @  A4 Toverpricing 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.
By “overpricing” we mean that prices detached from
5 `7 d2 \6 K9 n8 Z) \1 x! k+ wtheir fundamentals, as witnessed by a steep erosion of
5 b' L" @: T# w4 saffordability. The current unwinding of house prices reflects
. G! I' J/ J0 _0 q1 i: g) z, _both a cyclical downturn and a return of house prices
to fundamentally justified levels.
1 J' e0 q+ h  E( {We consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
6 V4 N8 N' Z% L; N, X" w7 mthat 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
/ t  ?, h& ?5 i% r6 o“overbuilding” was mainly of the first type, where
9 ?7 p- s- Z  U, G1 a7 ~( L3 }' {3 zhomebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
5 @$ J0 d8 O. S! I9 Kthe construction of too many new homes over the boom
$ Y. b, I% d1 z' {# v' W- Ameans a deepened slump. This overbuilding will likely weigh
on markets over the next few years. Even as Canada recovers
3 b7 @3 w! e# V! t( Efrom the cyclical downturn, house price growth will
remain choppy and new residential construction will be
6 m! o+ b$ \# o) n3 J5 G& t3 f( ?: ^dampened, owing to this structural weakness. Construction
; u! l" @! c: z7 r# Q. V' H, cis now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
residential construction will fall further to around
9 |0 k2 p# [7 z, D) b  _0 v" c4 c125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
' V3 M. d* s% a1 x1 {To quantify the degree of overpricing and overbuilding,
! i4 I0 V8 ~0 t/ Owe first develop an empirical model, based on long-run
) p+ m/ K0 s5 P7 ~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
; i: @% h4 ~/ J1 m! Rlong-run. Since homebuilders build to meet demand, we
3 o  b( ^" d, n7 t" K6 f) Jregard housing prices and household formation as the drivers
+ s* H5 q8 {1 C0 {$ V3 Iof residential construction.
To examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
$ d: R; r5 |) o7 J( Aoptimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
  S  N( y$ T0 Amany houses at prices that exceeded fundamentals.
1 `8 w0 u" ?" F1 _9 e1 v+ dRegionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
% @' q- |: j. G. y5 Ppopulation inflows. Saskatoon, Calgary and Edmonton are
already 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
has been relatively balanced but, while not plagued by structural
weakness, will be singed by the downturn nonetheless.
& ~: {6 y7 T  t$ o+ _2 gQuébec shows signs of strain – especially given the
strange accumulation of unabsorbed multiples on l’Île de
Montréal – but recent building has been relatively balanced,
1 z. r- y3 b$ hgiven the province’s history of under-building and low ownership
9 R3 N5 L+ m% I9 X; ~rates. While Ontario homebuilding will reel from a
7 x8 }' q* J. {0 X% q# F" scyclical downturn, the degree of structural weakness appears
6 i+ t9 ~6 c4 ?* X2 Q8 o+ plimited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
- S4 r; Y. I' e" `4 Pconstruction mean that record numbers of condos will
) l! ?+ C' w% c7 L6 B! }, X- ~reach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
" L. r  ~7 p2 M/ n% R6 _residential construction in B.C. will definitely droop, we
anticipate that the West Coast will continue to benefit from
' K8 I' d  C, sinter-provincial and international migration over the coming
years, which, along with improvements in affordability,
8 Y- T0 ?2 I! x# iwill alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
9 @/ o3 ?7 }5 H, _Grant Bishop, Economist
416-982-8063
Pascal Gauthier, Economist
416-944-5730
% `% T8 ^8 f5 `0 {; E4 Y+ T
$ Q, u3 L! T  B1 l4 G9 Ihttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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