TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
2 X/ `/ T( r! W% Wfrom 2002 to 2008, unsustainable price increases drove
, [3 V' C* Q3 [" t1 Cunsustainable levels of building. Our view is that house
prices exceeded the value of housing that was justified by
9 t) {) r5 H9 M# ^fundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
$ w% }- |- h. `. y# p; {that exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
. _* o- `" t: y3 t0 Athree years.
8 {6 ~8 h7 V3 l. cBy “overpricing” we mean that prices detached from
% Z9 ]; _+ U' r3 z( E& Z% y8 ztheir fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
both a cyclical downturn and a return of house prices
' _* ?/ ~; y. w! H7 Y3 mto fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
! G+ k$ D) Z5 i- z- q6 Awhere homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
  }  i6 H  g/ Y4 ^where builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
9 c7 r& |0 R0 a5 m$ G9 r. r“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
& Y, g# N, q2 d  {: _8 }6 KWhile most markets won’t face U.S.-style overhangs,
6 e, k9 m" v% B) hthe construction of too many new homes over the boom
( Y) Z) k, @1 W+ l" H2 i; Gmeans a deepened slump. This overbuilding will likely weigh
7 O; m$ V2 o  K4 M+ Bon 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
  V, ~: b/ n, q8 W0 Ldampened, owing to this structural weakness. Construction
. \3 i4 V. E7 `0 W; K; i0 fis now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
8 M4 t( e8 o4 j- U( O. Fresidential construction will fall further to around
# ?) c% v( w+ Z: t* o/ K' S' |125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
To quantify the degree of overpricing and overbuilding,
# h# @( @/ R; k$ b0 F% Zwe first develop an empirical model, based on long-run
fundamentals of house prices and housing starts in each
province. Affordability is the key concept behind home
% M' l) ~, _. @  Zvalues since house prices should track incomes over the
! I; z5 ]& G, c; Tlong-run. Since homebuilders build to meet demand, we
1 A0 ^0 N# q3 s/ w3 Z) Sregard 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
' p3 H! D4 I) |! c  ewould have occurred if housing had been priced
( g& ~; _* y9 ^, Q6 y! Xoptimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
4 O9 w' \4 W7 X' c* ^) `& mmany houses at prices that exceeded fundamentals.
8 b% W7 D7 n4 `7 U3 S% z" yRegionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
. e& I$ F6 g) A% h- mpopulation 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
buyers’ 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,
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
  W0 O3 u2 H* f0 i& Dcondo market. Both in Toronto and Vancouver, historically
' a0 G2 K/ q( {; ihigh levels of apartment-style units presently under
construction mean that record numbers of condos will
! [, z; K* K+ S+ ?( @2 g# v2 e  v+ L9 \reach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
' }6 |) o) g5 K  @' L6 D' Aspike severely – particularly in Vancouver. However, while
) {: D& u& k( D9 I: wresidential construction in B.C. will definitely droop, we
anticipate that the West Coast will continue to benefit from
8 }: Z6 c1 }) z3 W& D7 A; b$ hinter-provincial and international migration over the coming
  Q, u( N( r7 {7 gyears, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
; v; L; L4 c! S+ gGrant Bishop, Economist
% V3 V7 a. E) ~& s" h416-982-8063
3 x4 E$ H, S' BPascal Gauthier, Economist
416-944-5730
% F' y0 ?' o+ o! A+ n' H
7 u4 Z0 i1 b3 z7 A' p/ Z! ehttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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