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
6 Z- k5 z9 H3 Kprices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
; x  u" I+ ^2 p$ M( d- Ithat exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
three years.
* t' q9 f" W7 a7 n' DBy “overpricing” we mean that prices detached from
- u6 x  K% S# K2 `& Xtheir fundamentals, as witnessed by a steep erosion of
% P* a9 P4 o& m$ qaffordability. The current unwinding of house prices reflects
3 }8 w" c4 O  x* t9 wboth a cyclical downturn and a return of house prices
+ T+ A3 o) H- h4 h' R5 |to fundamentally justified levels.
& v- j/ ]1 L  V1 O# B% n, Z% GWe consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
$ M2 V2 y8 l9 \# j( ywhere builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
1 G4 h2 C" V& ~( ethat is now being rapidly reined in.
- m! r) o; r: E$ S% aWhile most markets won’t face U.S.-style overhangs,
- w) [3 a) Z- z7 N5 o/ W4 [6 athe 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
from the cyclical downturn, house price growth will
remain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
) J3 \' x& X& @7 c4 S( A& ]is now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
- ~' M# P6 A: ~residential construction will fall further to around
' {: d3 y3 d3 p  w. |125,000 starts over 2009 with a trough around 115,000 units
* x0 Y6 |4 S9 M) l# v3 |in the fourth quarter.
To quantify the degree of overpricing and overbuilding,
we first develop an empirical model, based on long-run
fundamentals of house prices and housing starts in each
# P+ D! r* X( A& k: s  `province. 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
, d& Z3 e0 w/ G" y( u) q0 k3 s: t1 z" Qregard 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
; B' q. d- f' Qwould have occurred if housing had been priced
" w/ ]3 Y8 Q2 soptimally. We find that actual homebuilding exceeded this
- ~5 m- X  [3 j; B' y; Afundamental-justified level by about 12%. Although new
% u. \0 L6 b) S: G  Zunits were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
! X- z& M3 S9 Z! ]) u+ J, hRegionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
# f" r- D6 o5 p% fpopulation inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
very time that the resale market has swung into strong
) X- Y. f* p& F" p5 }) [6 Z; gbuyers’ territory. Homebuilding in the Atlantic provinces
5 u5 R5 D; _: r% I+ Ihas been relatively balanced but, while not plagued by structural
: O; F4 s7 [& `2 J, ?weakness, will be singed by the downturn nonetheless.
: D3 i9 @6 i: j. Q1 u# zQuébec shows signs of strain – especially given the
) X1 F4 Z. S6 D: Y* mstrange 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
0 B/ s' f2 y, R) b' }1 M+ P1 Yrates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
: a5 _/ E4 C7 p! p) L2 q3 i* t" @condo market. Both in Toronto and Vancouver, historically
$ Q; O$ j9 ^' ~+ M' _" }  K' Ahigh levels of apartment-style units presently under
construction mean that record numbers of condos will
# t1 G: N, V9 ]) {" i6 \reach completion during 2009. If absorption rates fall, as
5 @* x  O' G  p* Ycyclical factors would indicate, condo inventories could
% g1 V' [, N, w' t  Tspike 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,
will alleviate some of the pressure from overbuilding.
* b( M; C3 w- H' GOVERPRICED AND OVERBUILT: CANADIAN HOUSING
, Z5 I" I% ~( b+ ]. MMARKET RETURNS TO FUNDAMENTALS
+ a7 O- a. Y: k3 X! Z$ T% GGrant Bishop, Economist
416-982-8063
+ M& d9 _( e! q/ m6 S+ F' fPascal Gauthier, Economist
# @/ T) k2 Z6 N! R3 b# U416-944-5730
2 N6 l5 N! t$ c$ p: ~
http://www.td.com/economics/special/gb0409_housing_exec.pdf

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