TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
: I6 a- {" {( n8 L1 dfrom 2002 to 2008, unsustainable price increases drove
unsustainable levels of building. Our view is that house
prices 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
12%, an excess that was exaggerated in the past
three years.
6 s6 v) B' B* ]: d9 E' ^  cBy “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
: C% l$ p2 Z; S' D7 Uaffordability. The current unwinding of house prices reflects
both a cyclical downturn and a return of house prices
  s& m" u+ H1 [$ q, `to fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
" y1 V7 x+ J0 j1 n# {5 D* `where homebuyers buy up too many houses and
; z- o5 f5 v' W. \" r2 A( Dthat this demand cannot be sustained; and “supply-driven”
7 C4 x: H( ?/ g. J; \2 B9 A" W! Wwhere builders accumulate excessive inventories. Although
5 F/ B1 @- J( `+ N0 X- s3 m+ jthere is evidence of both types, we contend that Canada’s
5 f6 e2 T/ b1 b9 l  l, j“overbuilding” was mainly of the first type, where
& e5 z# k9 n3 I6 L; C$ H' q+ ?+ Mhomebuyers 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
4 m4 N6 v, Y: k. Q" o" U' rmeans a deepened slump. This overbuilding will likely weigh
on markets over the next few years. Even as Canada recovers
# }8 f7 z9 {1 T9 N* ~' cfrom the cyclical downturn, house price growth will
remain choppy and new residential construction will be
* c9 m# A" e* ldampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
* ~! {2 J$ P; `to persist over 2009 to 2011. We anticipate that nationwide
! q' w( P$ g1 D% H1 r+ N* fresidential construction will fall further to around
/ O) k0 T; M/ [* D. M! s125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
0 Q7 A  a7 w# E: MTo quantify the degree of overpricing and overbuilding,
we first develop an empirical model, based on long-run
2 ~+ G8 {6 y  T5 \3 D) pfundamentals of house prices and housing starts in each
province. Affordability is the key concept behind home
3 W7 g- n/ H, Z  J1 U% J% Yvalues 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
; N. w; D" ~, n# `9 v0 X“counter-factual,” asking what level of residential construction
! `* s, N- F& `8 ~! x5 Cwould 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.
& x  p# p) S1 J# y5 A% XRegionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
7 F/ `/ D4 \1 t9 F4 apopulation inflows. Saskatoon, Calgary and Edmonton are
3 s6 h' {9 K+ Z* b2 X( calready witnessing surges in their unsold new homes at the
very time that the resale market has swung into strong
; P0 ?* `, ~* }' 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.
" X+ N! ~2 t% ?  AQuébec shows signs of strain – especially given the
6 ~: ~8 D, I0 s8 ^' }& l- Nstrange 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
( Q+ a* [9 }5 j7 N% t+ u' z( Ucondo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
3 {% }. ^, f5 p# qconstruction mean that record numbers of condos will
# u% j- d' ^2 B2 L2 Creach 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
" A- g  d' s) q, w# o" I/ C1 wanticipate that the West Coast will continue to benefit from
; b% u( e: w& U  Z" R- e' d& d4 Jinter-provincial and international migration over the coming
years, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
& }/ _9 m$ c1 @' [$ b) }416-982-8063
Pascal Gauthier, Economist
- x# W! U: s4 I5 w7 G% k416-944-5730

9 w" q  i  J: Rhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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