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
- P% o& `; m. C, yunsustainable levels of building. Our view is that house
prices exceeded the value of housing that was justified by
7 v- Z( \& x& F; Xfundamentals by approximately 9% nationwide. This
; M7 Y# ]) {6 b, ~overpricing compelled a level of residential construction
" k% W: ]# g" d; e8 Ethat exceeded its fundamental-justified level by approximately
2 {- v. F; ^* X+ q12%, an excess that was exaggerated in the past
three years.
By “overpricing” we mean that prices detached from
1 i" ^- U, E2 h0 V; l+ ltheir fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
2 i5 p& s, j" q$ p' `+ cboth a cyclical downturn and a return of house prices
7 }7 W' r* v- w+ x9 e) @to fundamentally justified levels.
  p0 r) J2 V* n: L/ \% sWe consider “overbuilding” of two forms: “demanddriven”
! h& S( m; N) d5 ?" r: J/ U+ zwhere homebuyers buy up too many houses and
3 l$ R# ?! B. M- Ithat this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
4 G% `1 v2 b. i  tthere is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
+ I, c1 R7 a" O4 ~$ p" O( fhomebuyers 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
means a deepened slump. This overbuilding will likely weigh
on markets over the next few years. Even as Canada recovers
0 x0 V$ n. q' k8 v: Sfrom the cyclical downturn, house price growth will
remain choppy and new residential construction will be
# y+ m, z$ Q) w) s: I" Gdampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
% Z3 i& K% Y  A( U$ [/ b" \to persist over 2009 to 2011. We anticipate that nationwide
* H" ~0 D& ^: ^5 w. r$ A- A% `9 A. i  sresidential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
+ L2 Y& i8 [! ^6 jin the fourth quarter.
To quantify the degree of overpricing and overbuilding,
. b8 Z* l) d4 F4 Z. d0 Qwe first develop an empirical model, based on long-run
+ W* X/ {$ L0 C% M/ |) Vfundamentals of house prices and housing starts in each
; \/ [' f2 f1 Y4 v& J/ Eprovince. Affordability is the key concept behind home
values since house prices should track incomes over the
' ^/ B, H. G# X& r) z! Mlong-run. Since homebuilders build to meet demand, we
regard housing prices and household formation as the drivers
of residential construction.
' v8 L/ h8 ?. G  A. S# fTo examine the degree of overbuilding, we employ a
! a* B1 W) z' I6 {) n. o) b“counter-factual,” asking what level of residential construction
; S# x3 q) K- w+ W0 |; N, Bwould have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
* {% Z* S! ]* Z6 Z( G, Xunits were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
8 e% d+ l6 i4 D& p& lRegionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
8 ]: w2 a9 `" Apopulation inflows. Saskatoon, Calgary and Edmonton are
! y' P, h+ I0 C; A8 ~% Lalready witnessing surges in their unsold new homes at the
& Q) i9 e$ q# P/ wvery time that the resale market has swung into strong
buyers’ territory. Homebuilding in the Atlantic provinces
. n0 i: S) E  z5 \& ~has been relatively balanced but, while not plagued by structural
weakness, will be singed by the downturn nonetheless.
# [$ }9 \: J, W+ N! b: 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,
  R/ t3 M& m  i. C: |, agiven the province’s history of under-building and low ownership
rates. While Ontario homebuilding will reel from a
( D* Y) Y. L/ J1 n8 jcyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
& Q6 A& e. D- r0 econdo market. Both in Toronto and Vancouver, historically
$ [2 [3 o4 k/ T: t$ ^0 d7 M2 O8 B; Rhigh 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
3 q( K8 y+ l% w2 x: aspike severely – particularly in Vancouver. However, while
residential construction in B.C. will definitely droop, we
2 R3 v5 d  s: I- f5 m* ]+ Uanticipate that the West Coast will continue to benefit from
inter-provincial and international migration over the coming
years, which, along with improvements in affordability,
% S' X) g0 h5 m! L# U1 t' o9 l3 mwill alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
, @8 g; u( ^! O* ZMARKET RETURNS TO FUNDAMENTALS
1 {* g0 [- s" b# J3 k7 iGrant Bishop, Economist
416-982-8063
Pascal Gauthier, Economist
) L: b" v4 n9 Q/ ^- N416-944-5730
: [0 @5 H* z) P% o0 a7 r& ^
( `2 R6 O3 H/ h/ @# c8 Shttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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