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
5 B' m  F8 g: e9 ~2 W' Lunsustainable levels of building. Our view is that house
prices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
! w& u- {1 ?- i5 j2 _0 a9 ioverpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
' c8 o$ Z% _  ?! Z! g12%, an excess that was exaggerated in the past
' Q! A# a+ h7 `! l3 G- othree years.
By “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
0 g! T: l3 F" @0 G0 M! F& I- Caffordability. The current unwinding of house prices reflects
$ h" p* p, [1 O$ h  m/ I1 z3 \  Pboth a cyclical downturn and a return of house prices
to fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
$ d' R; g6 n% |, J6 u# Awhere homebuyers buy up too many houses and
: l. v7 d3 v" s. k  z: c& W5 fthat this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
1 {$ e* R# W" ^8 j. ^3 othere is evidence of both types, we contend that Canada’s
+ T" U+ |0 K7 t+ L) \4 c* U“overbuilding” was mainly of the first type, where
! _: s5 _: A8 @( u3 x. Whomebuyers pushed homebuilding to an unsustainable pitch
. V' x! R" E1 {+ f4 i' vthat is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
& D! m: E: W$ F( a0 x/ x' m: E  Dthe construction of too many new homes over the boom
means a deepened slump. This overbuilding will likely weigh
" ]% P% P1 ^' ~& pon markets over the next few years. Even as Canada recovers
, n4 w/ f+ _  I# h1 a) u0 Z4 R3 [2 ]from the cyclical downturn, house price growth will
% X) l/ Q( H8 ?0 @( v( |remain choppy and new residential construction will be
/ B# P/ `$ U9 d- ~' Bdampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
residential construction will fall further to around
1 v) K* P) j  j' z# i* z7 b7 |/ S125,000 starts over 2009 with a trough around 115,000 units
; {. ]5 R( l6 z7 O: k2 h/ o! Ain the fourth quarter.
To quantify the degree of overpricing and overbuilding,
2 B. w7 g$ E3 E3 c2 p* Vwe first develop an empirical model, based on long-run
6 Y# P# D- ~# d! ?+ Q& C2 Yfundamentals of house prices and housing starts in each
province. Affordability is the key concept behind home
3 x6 N/ k2 [2 Y' ~( R( }# C3 `values since house prices should track incomes over the
long-run. Since homebuilders build to meet demand, we
0 |# F( _1 L7 d0 N2 r$ y$ xregard housing prices and household formation as the drivers
of residential construction.
- N& F) n) x. YTo examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
) y/ @" r- ?! R9 D: C0 C9 C0 awould have occurred if housing had been priced
0 o+ K# Y: S* V/ H$ uoptimally. 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.
5 o( t; G2 |, P" Q9 dRegionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
1 }* q* B" C0 x4 \0 Q/ N# F7 balready witnessing surges in their unsold new homes at the
: @) f2 V$ S; _' v8 Pvery time that the resale market has swung into strong
buyers’ territory. Homebuilding in the Atlantic provinces
: `7 Z6 e5 _7 }, s1 E8 x# ~has been relatively balanced but, while not plagued by structural
8 g5 N" s" Y0 X9 }( Rweakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
) |# S0 t  ]+ B" k4 L* Vstrange accumulation of unabsorbed multiples on l’Île de
! V4 Q, n! n  e; W. L; J( _6 kMontréal – but recent building has been relatively balanced,
: H) s8 `* X' e: y" Tgiven the province’s history of under-building and low ownership
rates. While Ontario homebuilding will reel from a
. d; r* w' t+ Kcyclical downturn, the degree of structural weakness appears
1 h, n! V' {* G4 B$ t- K! f3 O( q- Zlimited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
* i1 o1 ^0 a- {7 s0 b3 d' h. Zconstruction mean that record numbers of condos will
6 G: L6 `9 Y5 c3 q6 v  Greach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
* R- a5 ^0 d6 ^' @! R) B1 Y' Eresidential construction in B.C. will definitely droop, we
( s4 x7 L# s6 R7 u! Panticipate that the West Coast will continue to benefit from
5 c& J' O' M- r8 i, l$ n5 C) p$ Vinter-provincial and international migration over the coming
years, which, along with improvements in affordability,
( Z1 O5 H# H; o' R. ]will alleviate some of the pressure from overbuilding.
% m; |: S' ^1 u* p" zOVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
) C1 w2 x' G# `6 _# y! HGrant Bishop, Economist
( i  L( h+ ]/ Y; s! w. n416-982-8063
Pascal Gauthier, Economist
. Z) s0 ~+ n; {: e: j6 t8 U4 V0 O416-944-5730

) s- K0 P7 c. g- hhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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