TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
. X$ R  `/ A' d# Yfrom 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
* N3 i4 V* A9 @7 moverpricing 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.
* [& @! N/ P7 v4 z( i3 wBy “overpricing” we mean that prices detached from
8 R2 f+ B' b' @$ V4 A) U  T7 K  Stheir fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
) |% N+ u6 c  ]both a cyclical downturn and a return of house prices
to fundamentally justified levels.
$ @0 i; W* E9 [We consider “overbuilding” of two forms: “demanddriven”
5 m# h2 u' M/ k; E$ vwhere homebuyers buy up too many houses and
- w- P- D# m, ~2 N9 xthat this demand cannot be sustained; and “supply-driven”
0 [( N3 J* u6 c7 `where builders accumulate excessive inventories. Although
9 J) ~3 S! I/ }there is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
: k. Y6 s5 t% {- q2 _% V7 [9 vhomebuyers pushed homebuilding to an unsustainable pitch
& H& ]2 B: D# g, Ithat is now being rapidly reined in.
0 }7 O7 j& N$ U) @6 AWhile most markets won’t face U.S.-style overhangs,
+ t: a3 _" A! {% @& o, v. {3 a" Z5 T# zthe construction of too many new homes over the boom
! n2 C6 b. R, g: lmeans a deepened slump. This overbuilding will likely weigh
+ s) F  U+ l( ^4 c/ a0 Pon markets over the next few years. Even as Canada recovers
: I3 A4 F5 Q) G3 [from the cyclical downturn, house price growth will
( d; W  P& q$ j+ b* eremain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
& J. s: y, [; Uis now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
. h' H; m+ P6 Xresidential construction will fall further to around
4 J8 O6 _& o6 m  v: a' H: v2 G* t125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
To quantify the degree of overpricing and overbuilding,
" _- [9 m9 C/ V; ^9 Uwe first develop an empirical model, based on long-run
( m$ y. x* t/ c) ]( x2 [fundamentals of house prices and housing starts in each
province. Affordability is the key concept behind home
) \3 P# `8 ^( ^* ^! x5 dvalues since house prices should track incomes over the
long-run. Since homebuilders build to meet demand, we
1 O% L# @& R! N$ {1 q' ]" t, Sregard housing prices and household formation as the drivers
* R, t" [1 T% T9 ^) Zof residential construction.
6 y: Z* m/ B9 i6 N2 p: G- kTo examine the degree of overbuilding, we employ a
  {7 J1 V+ W6 h% e. W; H& k“counter-factual,” asking what level of residential construction
8 Q: k" C. G& C+ n; fwould have occurred if housing had been priced
2 R; X" l& a8 q, z! X1 u3 foptimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
5 |& Y+ h$ r7 I/ ^units were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
! E* w' Y( c% b, o' vRegionally, we see the greatest strains on the Prairies,
# Y4 B; \9 c4 x1 Z# ^: a# xwhere housing demand will further contract under waning
% n  L9 Y7 v5 V7 g' ]) Rpopulation inflows. Saskatoon, Calgary and Edmonton are
9 U& E/ v1 Q% \! z5 E. u1 \already witnessing surges in their unsold new homes at the
4 g$ V' L* f9 S9 K0 `) T; dvery time that the resale market has swung into strong
buyers’ territory. Homebuilding in the Atlantic provinces
5 _+ o% K* i5 W( C+ k, `7 ]$ L& Qhas 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
2 k: T0 y* A6 U2 U2 G" Q. srates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
, r8 u! W! c( G8 h) @high levels of apartment-style units presently under
construction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
6 b5 A, |/ Z8 |8 m! Ecyclical factors would indicate, condo inventories could
$ O  J* K, z. Gspike severely – particularly in Vancouver. However, while
' E* K+ L1 H$ L5 _0 A) C2 n/ y2 hresidential construction in B.C. will definitely droop, we
anticipate that the West Coast will continue to benefit from
/ o, {! i! \, Pinter-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
7 y- J% X$ m' w7 n5 D; g6 QMARKET RETURNS TO FUNDAMENTALS
& I7 I  A3 c- V6 f. j* LGrant Bishop, Economist
( C' e& _6 ^/ c' a- P& D7 C. p3 H416-982-8063
Pascal Gauthier, Economist
416-944-5730

- E( C% L5 \& k$ C- Xhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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