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
+ E3 U' n0 @) Y  U! @8 sunsustainable levels of building. Our view is that house
9 {9 I6 {; b  ~' x5 |% ]prices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
overpricing 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
their fundamentals, as witnessed by a steep erosion of
4 ^2 I! m& y2 ~8 d4 H7 Taffordability. The current unwinding of house prices reflects
both a cyclical downturn and a return of house prices
to fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
5 q$ a; D- J) L5 ywhere homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
! B3 G9 U- w3 p$ m) K- t0 {where builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
: g. f" n& U/ b, w! Ahomebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
' s5 A4 i) D$ u5 QWhile 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
; k7 D6 _! Q& n  }4 l& r" bfrom the cyclical downturn, house price growth will
4 l' v9 p; Y3 D: ~remain choppy and new residential construction will be
+ b  Y8 k/ B! f% G0 Fdampened, owing to this structural weakness. Construction
0 _  A  d. Q7 U! bis now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
- e$ i9 m5 t4 ?' }& T. mresidential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
  X: T) q/ f9 J0 Y1 n* |in the fourth quarter.
$ Z9 H( J8 U5 C% [To 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
$ i5 D: D3 C8 }values since house prices should track incomes over the
4 T% k: m6 _7 D' O6 R* R! \3 Q  Mlong-run. Since homebuilders build to meet demand, we
regard housing prices and household formation as the drivers
of 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
optimally. We find that actual homebuilding exceeded this
* c$ s8 @9 ~0 v. k1 q* X1 ufundamental-justified level by about 12%. Although new
: @) G# t+ k3 J# c9 runits were being absorbed, homebuyers simply bought too
4 Y7 B" G( B( kmany houses at prices that exceeded fundamentals.
* V. I# A+ Y2 V8 |  e5 o% pRegionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
4 J" v8 ]$ L5 z& ]: ]( X2 M) O! N5 ]6 M) `population inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
5 D/ ~/ h1 B3 z& |2 overy time that the resale market has swung into strong
3 ?3 a3 [/ J. n1 c: R9 }buyers’ territory. Homebuilding in the Atlantic provinces
* M& I: G" Y$ v) p7 }( Bhas been relatively balanced but, while not plagued by structural
8 D% t% l: ^/ K+ f. H: _weakness, will be singed by the downturn nonetheless.
5 V6 @0 i* B; T- n% c8 i. o! C. ]Québec shows signs of strain – especially given the
, [* {  A$ q% U- L; g! f9 ?4 Rstrange 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
rates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
# r0 f: f# C0 s0 bcondo market. Both in Toronto and Vancouver, historically
7 |5 z3 i+ p7 L! u+ thigh levels of apartment-style units presently under
construction 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
9 h" s# |( r/ E0 v2 @  y6 h& @( lresidential construction in B.C. will definitely droop, we
& M/ W& T1 E* P) J6 vanticipate that the West Coast will continue to benefit from
( L: d' i& e$ }# ?: L/ \inter-provincial and international migration over the coming
years, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
* L$ W' q( f' U6 HGrant Bishop, Economist
416-982-8063
' r2 V$ M- K% K' oPascal Gauthier, Economist
416-944-5730
  x& e& X4 i' U4 r: k; f* C& F
" l8 T1 @7 m7 m$ L3 shttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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