TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
4 M; Y0 v; s- ifrom 2002 to 2008, unsustainable price increases drove
/ A4 y4 O- E6 v6 ~* V  h9 j  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
% D1 f0 Z8 v7 |  |0 U2 Koverpricing 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.
7 _9 A. y+ i# ^  B9 ~. N9 CBy “overpricing” we mean that prices detached from
9 N2 D# x0 b; V+ G: X2 s  c/ ~4 ctheir fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
' y- v& }) C: ^) }0 Gboth a cyclical downturn and a return of house prices
* Z$ }9 ]' S: q, f; E0 Z/ k/ dto fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
: \! f, K0 I- V- j3 x7 |6 bwhere homebuyers buy up too many houses and
, c4 {8 p+ b; a7 k: {that this demand cannot be sustained; and “supply-driven”
! ~' T2 D/ c6 Z" B* ]" N1 M% |( h1 hwhere builders accumulate excessive inventories. Although
# ~6 g* g4 {1 f, q7 Qthere is evidence of both types, we contend that Canada’s
, b1 E. w, A# b/ l% g6 _“overbuilding” was mainly of the first type, where
) @8 J  s) T1 Xhomebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
. C, l8 u$ \7 v* {5 hthe construction of too many new homes over the boom
0 R/ q. S+ `- k# i" Xmeans a deepened slump. This overbuilding will likely weigh
on markets over the next few years. Even as Canada recovers
4 O7 v7 w9 S6 x9 @3 Ufrom the cyclical downturn, house price growth will
remain choppy and new residential construction will be
6 I5 a3 G* _8 t6 ^0 n0 H0 _8 Tdampened, owing to this structural weakness. Construction
4 @4 ^. l# r7 q# k4 @is now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
& p: X. O& L6 y* L) o1 Qresidential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
: c% r; h6 V4 xin the fourth quarter.
7 ^* j- ~8 H% h9 hTo quantify the degree of overpricing and overbuilding,
we first develop an empirical model, based on long-run
# {% C- O+ y" B5 \fundamentals 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
! }- V5 }" w1 }long-run. Since homebuilders build to meet demand, we
$ J4 V6 |0 F; [- Cregard housing prices and household formation as the drivers
  m3 S; Q& T- Q% T3 J/ Kof residential construction.
To examine the degree of overbuilding, we employ a
- @" r1 K+ i, ~“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
0 F7 v! \2 [2 V# [fundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
4 w. Z, e; ]- V' q/ j; {Regionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
' C) a/ r9 b, ~population inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
' c2 K* I4 {7 P7 p2 z1 f9 Xvery time that the resale market has swung into strong
$ c3 I  `$ U. F0 hbuyers’ territory. Homebuilding in the Atlantic provinces
( i+ O8 ^/ Y: i: v* D. C9 Fhas been relatively balanced but, while not plagued by structural
. w4 n- \, y/ r- e% `weakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
) x) j3 X/ O; q" sstrange accumulation of unabsorbed multiples on l’Île de
Montréal – but recent building has been relatively balanced,
: U. {& W4 _, R+ G, M3 s" Q) |. Rgiven the province’s history of under-building and low ownership
: E: z  T6 r2 U2 O5 q8 N+ R& S1 Rrates. While Ontario homebuilding will reel from a
+ t% N# P4 D) ~1 ecyclical downturn, the degree of structural weakness appears
; {1 g9 K  E' r, [: Alimited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
0 C5 ~, ~* Y3 G- }) c) V2 H. v4 shigh levels of apartment-style units presently under
construction mean that record numbers of condos will
! E% s9 Z+ f8 G" S0 xreach 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
' u9 b1 C5 T) J0 _# x* N( ^5 Manticipate that the West Coast will continue to benefit from
# V& k0 ^* k3 d& q" o/ @inter-provincial and international migration over the coming
! q6 w4 [# y5 e% y. [years, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
! h2 C: E6 s& K- }MARKET RETURNS TO FUNDAMENTALS
) M. c9 Y# t' aGrant Bishop, Economist
416-982-8063
Pascal Gauthier, Economist
416-944-5730
' p6 A9 F" M: D9 {
http://www.td.com/economics/special/gb0409_housing_exec.pdf

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