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
  z  b; t9 R! x+ P' B7 Zprices 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
$ `) o) {$ n' G# P8 P& D12%, an excess that was exaggerated in the past
  a7 R: t, K8 u$ U3 h" Tthree years.
By “overpricing” we mean that prices detached from
+ }; |% _3 h9 W% f& f$ i- @their fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
) F& v. s% D% T9 m' p9 Q1 i' kboth a cyclical downturn and a return of house prices
6 M8 d* R, e( ]. O( Q' Hto 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
5 B/ U% Y: L0 J( Hthere is evidence of both types, we contend that Canada’s
! Q0 i  Z2 R+ J7 C“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,
: X- K8 f8 |/ t3 G6 V7 q- }& F  kthe 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
& @* u/ [( e( a5 {# i. g4 k* d- cfrom the cyclical downturn, house price growth will
remain choppy and new residential construction will be
0 k! |; e, k: J8 P3 N. Wdampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
$ |7 _1 V5 q+ G  ^to persist over 2009 to 2011. We anticipate that nationwide
- |0 U. z  N. h6 O& ^$ rresidential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
2 X# J+ T2 a  wTo quantify the degree of overpricing and overbuilding,
) z5 n" W) g# Swe first develop an empirical model, based on long-run
; R# S. I' t# C( d7 w& afundamentals of house prices and housing starts in each
( j1 m5 ?7 O; c" Q# V% `9 R0 S2 V+ N: vprovince. Affordability is the key concept behind home
0 q9 \  K" s, D! x: S7 Y- X' \( O( Q5 svalues since house prices should track incomes over the
long-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
% t  X. |+ h. q: C( awould have occurred if housing had been priced
7 F- J5 s6 u3 m1 s9 l8 {9 v7 ^optimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
3 w, A1 I( M4 q) X9 M3 E4 rmany houses at prices that exceeded fundamentals.
8 z9 @/ O% a( M( R1 O- [# zRegionally, we see the greatest strains on the Prairies,
6 {9 C; J$ u( swhere housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
* [" i) ?* W) k& A/ m2 x+ |already witnessing surges in their unsold new homes at the
very time that the resale market has swung into strong
5 L4 I% i* {3 \% {$ _9 X* k8 Ubuyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
8 U$ O( l" z4 u" |/ @weakness, will be singed by the downturn nonetheless.
6 Z! O2 [& W2 \3 T' B& L) R6 v  ]6 d4 {Québec 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
rates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
& n4 S- ^) Q6 {, N* phigh levels of apartment-style units presently under
, z9 v0 j1 k) S$ ^construction mean that record numbers of condos will
# Y/ p0 k- I) h- a6 V6 P# nreach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
residential 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,
  M- B5 j& O- w& e0 ewill alleviate some of the pressure from overbuilding.
: t: _  \  E0 }1 v2 D; v, `OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
: U2 v+ [2 z1 U% `9 z7 y# D. y416-982-8063
Pascal Gauthier, Economist
416-944-5730

1 b+ t3 e9 a, a/ Thttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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