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
- F8 Z% q. w" Z( `6 lunsustainable levels of building. Our view is that house
4 k1 @: H9 i: |9 ~* S8 Kprices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
& ~/ x+ s2 B; q3 p% L: V- i8 vthat exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
three years.
9 B* y! }8 u4 C0 X! p' a: Q% KBy “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
7 x1 d: U+ \8 B4 E# Kboth a cyclical downturn and a return of house prices
' S% J+ P; m  Z3 I3 Q+ Pto fundamentally justified levels.
* ]% T: q5 S+ R( h; h  ?7 e+ zWe consider “overbuilding” of two forms: “demanddriven”
# k4 V8 R2 Q% Pwhere homebuyers buy up too many houses and
( y% @' L9 f1 F% g) W4 a0 c4 N7 cthat this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
% Z0 D/ c$ o; }homebuyers pushed homebuilding to an unsustainable pitch
- z, _' ~% c9 p. [that is now being rapidly reined in.
. Z! l0 I# }8 E5 KWhile 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
- m2 N% w3 f9 [7 P5 z1 pon markets over the next few years. Even as Canada recovers
) s; c1 c' o# w' nfrom the cyclical downturn, house price growth will
7 Z5 ?6 v- x4 s0 Cremain choppy and new residential construction will be
$ f4 A/ c* F' `# [dampened, owing to this structural weakness. Construction
/ D5 @* W! g. t. @5 u* r2 V4 L! Y5 ^is now undershooting fundamentals and we expect this
; r* ]: k% R! H0 g4 r" }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.
: m* U- ~( ]. C3 \. Q: j. HTo quantify the degree of overpricing and overbuilding,
& U6 k' Q$ O, g) a6 w, xwe first develop an empirical model, based on long-run
fundamentals of house prices and housing starts in each
6 e9 g1 l  ?  \1 e/ t8 U. Tprovince. Affordability is the key concept behind home
values since house prices should track incomes over the
) G! A4 h, |6 u  ]6 H; x$ @long-run. Since homebuilders build to meet demand, we
regard housing prices and household formation as the drivers
+ K. _5 _1 }4 S6 u9 Eof 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
units were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
. A2 u: W0 M; p$ i. Calready witnessing surges in their unsold new homes at the
. |; W* y& }+ A( }9 {+ ~+ rvery time that the resale market has swung into strong
buyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
7 R( B: d# [- ]0 fweakness, will be singed by the downturn nonetheless.
, Y! y: e" h) S# u+ v$ W" I6 R/ b: PQuébec shows signs of strain – especially given the
4 m6 c, @2 P/ y6 Y: o) ]5 kstrange accumulation of unabsorbed multiples on l’Île de
# o+ @  l6 l$ s. ?' x! kMontréal – but recent building has been relatively balanced,
& q9 ^2 I# y! f7 i" e2 A+ R% y3 |  qgiven the province’s history of under-building and low ownership
- t- }* e+ U2 `) o. {rates. While Ontario homebuilding will reel from a
+ |9 l  D+ _5 @8 H) q' f# Y/ pcyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
6 P" b  s( l' o6 X& }" uhigh levels of apartment-style units presently under
construction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
# ~# R* X/ P( ocyclical factors would indicate, condo inventories could
2 z# q& s( j+ F8 dspike severely – particularly in Vancouver. However, while
2 D4 z: m# x( {0 J: d3 s" Kresidential 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
3 T* T7 w3 i$ D$ Syears, which, along with improvements in affordability,
7 V+ \4 p( i) U$ R* z. n. k3 owill alleviate some of the pressure from overbuilding.
, u% l* @7 h* @) GOVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
1 E- B7 e. T2 G  [; Q& QGrant Bishop, Economist
416-982-8063
Pascal Gauthier, Economist
416-944-5730

1 w1 m4 p1 n( j6 d- Hhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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