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
' N) I$ D. U5 v2 ^5 m4 Ounsustainable levels of building. Our view is that house
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
: I% ?$ J% B+ F% Q7 O7 ?7 n% J! S- Ethree years.
; y' x. E$ |" z1 bBy “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
, r3 f0 [  Q. J3 z; h* x, t8 mboth a cyclical downturn and a return of house prices
4 T$ @' t' F' rto fundamentally justified levels.
& S& H. B0 P$ c3 lWe consider “overbuilding” of two forms: “demanddriven”
  g6 A" u9 W3 `8 c0 awhere homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
2 E. b7 m$ b, r" f. Z: ^+ t2 Nthere is evidence of both types, we contend that Canada’s
* b4 I6 }& f$ [  L, P; ?$ q: p“overbuilding” was mainly of the first type, where
# Q" M* G5 `" R' w7 G' lhomebuyers pushed homebuilding to an unsustainable pitch
, J' S! z# U0 c5 qthat is now being rapidly reined in.
4 b8 ^* v5 Y- Z0 e3 z1 _$ v+ 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
" F7 g9 u. d7 v, Xon markets over the next few years. Even as Canada recovers
from the cyclical downturn, house price growth will
remain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
0 A1 h4 }* q- y5 j/ L( z  Yis now undershooting fundamentals and we expect this
; S) Q) r/ S) h5 Z% eto persist over 2009 to 2011. We anticipate that nationwide
8 C3 _% D/ V9 a0 d8 n' Presidential construction will fall further to around
$ O( |9 C, E* n8 s125,000 starts over 2009 with a trough around 115,000 units
5 f2 o7 v, |2 c+ S& xin the fourth quarter.
6 W* ^+ U( n7 \/ |$ [/ ~To quantify the degree of overpricing and overbuilding,
we first develop an empirical model, based on long-run
; E# x4 ~% J4 ~1 b2 Q, Qfundamentals 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
7 ]; c& E# [5 Y* `long-run. Since homebuilders build to meet demand, we
' D- [% o2 t. ?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
: _% e6 a) X% x* F- E' Coptimally. We find that actual homebuilding exceeded this
4 C7 f1 J# o* s  ]. I8 Tfundamental-justified level by about 12%. Although new
* T( w0 l1 ~" p* |$ o2 u" ounits were being absorbed, homebuyers simply bought too
) R0 l' q  T! q! }  A- Mmany houses at prices that exceeded fundamentals.
/ G6 L$ W3 {8 ~6 ]( _Regionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
4 ?* a' i; x6 G' `9 W$ Valready witnessing surges in their unsold new homes at the
very time that the resale market has swung into strong
' k& w: Q# r- ]. s. w& mbuyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
weakness, will be singed by the downturn nonetheless.
, u% a5 s7 t: v9 G3 rQuébec shows signs of strain – especially given the
strange accumulation of unabsorbed multiples on l’Île de
Montréal – but recent building has been relatively balanced,
( f2 `0 |* x$ S3 F9 u# E4 T. b3 M7 Vgiven the province’s history of under-building and low ownership
7 T5 r7 ~$ P5 X2 Y! C+ krates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
- M8 x" o: A% Mlimited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
# f2 h3 ]4 J/ |5 r  Z8 K9 Q6 |) Whigh levels of apartment-style units presently under
; `# m; Q) n0 ?( _4 Vconstruction mean that record numbers of condos will
3 D. C6 V' Q8 D5 R4 |5 y( u- Ireach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
: L5 I4 {  E, u. J8 Q% Z& O) Mspike severely – particularly in Vancouver. However, while
3 h- f3 d) u" k( w: k) {$ e  Wresidential construction in B.C. will definitely droop, we
9 T! A6 b2 d9 i. M: |0 hanticipate that the West Coast will continue to benefit from
inter-provincial and international migration over the coming
  `) q; S1 b% {2 m$ Eyears, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
$ _1 P! d' T& ^' t5 iMARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
0 F% k" z) h( ]4 U( cPascal Gauthier, Economist
( i. P8 f4 e* C+ j$ ]416-944-5730
! Z- T7 m& \- q. A, L
' P+ {& P& q5 {% L, m/ @" ~' Mhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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