TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
8 O3 E; ?% b6 C& d: Zfrom 2002 to 2008, unsustainable price increases drove
unsustainable levels of building. Our view is that house
9 a0 j/ ^0 U+ kprices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
; |+ a, A" H0 H6 L5 Xoverpricing compelled a level of residential construction
: j$ S; i/ \5 M1 dthat exceeded its fundamental-justified level by approximately
. }' ~" K6 h" ?- ]12%, an excess that was exaggerated in the past
% a$ w6 C! h! X+ F, Mthree years.
By “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
8 B& p, X: |8 Naffordability. The current unwinding of house prices reflects
both a cyclical downturn and a return of house prices
# T8 z" T% ~6 d$ I& Sto fundamentally justified levels.
% K2 u: ?* C& {/ W1 b8 ZWe consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
- i0 z+ \) ^" u+ |8 v- Y9 X$ Vwhere builders accumulate excessive inventories. Although
2 c% P! |: ]. k" z; c/ @9 uthere 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
" x2 t, Y# W; Q3 Q! c3 Athat is now being rapidly reined in.
# j; f- O6 O3 a- N+ Q9 H5 o% _While most markets won’t face U.S.-style overhangs,
- t5 k4 w8 f1 Z9 W( mthe construction of too many new homes over the boom
% G( G! w6 w4 ?, w% y1 @means a deepened slump. This overbuilding will likely weigh
8 ~6 _7 w( C0 R: o) C, \on markets over the next few years. Even as Canada recovers
- e, D! x5 J" _6 U# Nfrom the cyclical downturn, house price growth will
5 Q  ~/ f" r7 z' Wremain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
( W  }; k9 d% L; j8 Y! b' ~to persist over 2009 to 2011. We anticipate that nationwide
residential construction will fall further to around
. y% d! F& |+ e; z9 S, Y0 j125,000 starts over 2009 with a trough around 115,000 units
; V0 \* d8 O3 v! E" Lin the fourth quarter.
To quantify the degree of overpricing and overbuilding,
we first develop an empirical model, based on long-run
" I7 B6 i- u: ^6 d7 o' O& M, ^" R7 f7 Ufundamentals of house prices and housing starts in each
province. Affordability is the key concept behind home
values since house prices should track incomes over the
, z, x+ r% K0 E! ]$ @8 O0 Flong-run. Since homebuilders build to meet demand, we
5 p, J4 B5 {: P) D. U5 S# tregard housing prices and household formation as the drivers
& |5 l2 \  U6 f9 m5 Cof residential construction.
To examine the degree of overbuilding, we employ a
7 J% Q" e) r9 A, @) c“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
: {) O8 q+ P& n' k/ P6 w" n9 Joptimally. We find that actual homebuilding exceeded this
- k6 Y, Z5 A2 c6 `8 i3 @4 dfundamental-justified level by about 12%. Although new
$ ^: ]4 Y" t1 {1 r# M  @1 funits were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
% [1 i' F+ v! mwhere housing demand will further contract under waning
- |$ P  j3 x# ~9 i6 `population inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
8 k0 y  ?2 y7 E0 M  m/ i7 c% I( mvery time that the resale market has swung into strong
buyers’ territory. Homebuilding in the Atlantic provinces
9 A% r; _- A% _$ Zhas 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
) N: o8 H) J5 z4 p1 K9 Ostrange 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
/ O& A( z5 C$ }cyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
+ D0 y- d5 V9 N+ S/ Z0 V" ^construction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
* |# u! I$ g. h; U: Ecyclical 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/ F, {7 z. F( rwill alleviate some of the pressure from overbuilding.
7 @; V5 o  S6 c0 q- {; D: o2 Y/ ?7 yOVERPRICED AND OVERBUILT: CANADIAN HOUSING
7 ^+ w5 O. G- |0 J6 NMARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
Pascal Gauthier, Economist
; s3 s% P# V5 O416-944-5730

9 }( P. b0 v9 a/ p+ ~' C" k' Lhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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