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
! ?# h3 G- [- q$ u/ W- p& aprices exceeded the value of housing that was justified by
6 E) n% Z0 q* z( o- z6 r: afundamentals by approximately 9% nationwide. This
* P  N' s% i7 d) Boverpricing compelled a level of residential construction
- U; Z* h* e4 n/ Y: vthat 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
& ?; X2 _7 ^$ B# Q# Rtheir fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
1 Z8 k$ r+ f7 o" f2 |: lboth a cyclical downturn and a return of house prices
  l3 P% x8 q6 g7 Q& Kto 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
8 p0 G& b! n2 ]2 X: f& m6 Fthere is evidence of both types, we contend that Canada’s
( b! H3 n9 J' N5 a8 ?/ x) P“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
the construction of too many new homes over the boom
+ G- j' |$ v7 L# I5 b, ?1 _2 hmeans a deepened slump. This overbuilding will likely weigh
on markets over the next few years. Even as Canada recovers
from the cyclical downturn, house price growth will
9 I2 D9 r$ D! d9 L1 O2 J' Lremain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
( V4 J2 W6 S9 u, ois now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
residential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
To quantify the degree of overpricing and overbuilding,
* t8 \# ]( V4 ?* O0 R# F! l" Uwe first develop an empirical model, based on long-run
fundamentals of house prices and housing starts in each
4 ?3 F8 j0 k  G2 Y0 B8 m  Xprovince. 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
, g: V/ ]' J1 A% z5 y$ T- rregard housing prices and household formation as the drivers
of residential construction.
: S5 [2 p" `. U9 a  B; c9 r8 qTo examine the degree of overbuilding, we employ a
. o8 k, g- [# t# c6 O4 k6 y“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
$ t0 H) o7 z" N: s  S& Lfundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
$ l+ S0 q5 T3 U9 J# hmany houses at prices that exceeded fundamentals.
; v( l$ I( f" }: Q( q, l7 N) [Regionally, we see the greatest strains on the Prairies,
( V: r7 u5 |) [' a! U; S4 ]where housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
: |) P3 `9 D9 [. \2 jalready 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
$ y) X1 b; `! I, A4 _/ H2 i8 rhas been relatively balanced but, while not plagued by structural
1 ^% s+ D, z, r5 Wweakness, will be singed by the downturn nonetheless.
  u) u  B! M/ AQuébec shows signs of strain – especially given the
strange 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
1 `! M1 b% q% x' K- K0 M- `. I2 k; `4 prates. While Ontario homebuilding will reel from a
& ^/ @9 P2 C' m. q0 Dcyclical downturn, the degree of structural weakness appears
8 e4 Q& r7 x, G* [- Plimited – with the important exception of the Toronto
# z; C7 u3 A' W# s& `6 n! acondo market. Both in Toronto and Vancouver, historically
3 X! l" B/ d' ~6 yhigh levels of apartment-style units presently under
construction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
" ^' P, w( J) ~; A3 m. {( f% Jcyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
0 e8 `* M' }7 @& c1 Y' Fresidential 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,
will alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
! T. u  T8 I7 F! s$ @. y7 wGrant Bishop, Economist
416-982-8063
" D- l, f3 ?, y# `Pascal Gauthier, Economist
416-944-5730

# p1 D) ~- V. d$ Yhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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