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
: I+ S. o9 x8 Q- r0 a& [* Bprices exceeded the value of housing that was justified by
8 \2 G5 i# Y/ K9 kfundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
# }/ N% v& u4 n) a  o5 L* wthat 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
. p" ?1 O4 ^3 Ptheir fundamentals, as witnessed by a steep erosion of
; b3 G. T5 a% m; n  f: h5 |1 taffordability. The current unwinding of house prices reflects
# |9 l( M5 B- a7 ]* M& kboth a cyclical downturn and a return of house prices
" M+ O. ]9 [. x% z! f& _to fundamentally justified levels.
. R5 |9 Y5 O6 o7 B/ KWe consider “overbuilding” of two forms: “demanddriven”
; V4 T- Y" j2 v2 T2 |. V* fwhere homebuyers buy up too many houses and
$ C7 I+ m. C7 ^; wthat this demand cannot be sustained; and “supply-driven”
' E2 j" v' x* U  Gwhere builders accumulate excessive inventories. Although
6 I! o4 A+ W: R2 z  z" F$ }0 vthere is evidence of both types, we contend that Canada’s
/ F* P2 d' }, T9 I- {; \. y“overbuilding” was mainly of the first type, where
0 K4 D, K2 s$ ghomebuyers pushed homebuilding to an unsustainable pitch
* c. n' K5 n+ h) [. H1 B1 Ythat is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
& ]. B; x/ l8 \4 y1 E8 Z3 W! e# jthe construction of too many new homes over the boom
5 \; S- B" T7 N- z; _6 Zmeans a deepened slump. This overbuilding will likely weigh
on markets over the next few years. Even as Canada recovers
# p+ ]6 o; [+ J+ R0 C% U  wfrom the cyclical downturn, house price growth will
* L; D; {% Z# C# W* n( v. V* xremain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
7 M* }# _0 e$ x9 }) Hto 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.
9 j5 B* O4 t1 I# ~1 k4 y  mTo quantify the degree of overpricing and overbuilding,
, p: {# t7 q! q% [( B2 q8 ~# Swe first develop an empirical model, based on long-run
+ _# V6 i! c. c" P! F* o. {fundamentals of house prices and housing starts in each
/ n' d, _9 u: l. W& lprovince. 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
regard housing prices and household formation as the drivers
8 p1 r- q+ F: T- w. `* X. I7 jof 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
fundamental-justified level by about 12%. Although new
* D  ^9 P* L+ u- C/ ?units were being absorbed, homebuyers simply bought too
  ?7 ], T8 v: t+ t5 X8 Omany houses at prices that exceeded fundamentals.
. E# M" T7 k7 HRegionally, we see the greatest strains on the Prairies,
8 z4 z6 l) _0 s; K( x% ]where housing demand will further contract under waning
) `3 @- Y+ N) p/ c# S) rpopulation inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
9 Q* t( c1 R7 t0 q, G* \very time that the resale market has swung into strong
, }2 L% \0 V% m' |4 Y( x! z5 ybuyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
weakness, will be singed by the downturn nonetheless.
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,
- w! U3 X8 m# ^+ n6 ]given the province’s history of under-building and low ownership
" o9 {" W% Q2 O6 e6 w: _8 Brates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
! S3 m5 m# e* u+ A5 K0 S" Glimited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
! S+ Z$ X; ~" g% o4 d8 E) jhigh levels of apartment-style units presently under
. K0 L0 E6 Z" u" {5 sconstruction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
$ L, p$ r% B- wcyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
3 m( |+ H) Y* F$ _residential construction in B.C. will definitely droop, we
  u2 F$ C0 V& G4 j" xanticipate 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.
+ f0 ]; G, E* [/ n7 wOVERPRICED AND OVERBUILT: CANADIAN HOUSING
& H% I* B* W+ l/ aMARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
Pascal Gauthier, Economist
416-944-5730
5 B. R$ a/ r. Z7 B: m
3 p; x9 p7 H* Xhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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