TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
) l/ I7 |5 ], N" y6 K9 pfrom 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
9 d& C6 C8 Y- ~  doverpricing compelled a level of residential construction
$ I1 \# d4 W" ]3 T- m9 r$ ~0 Ithat exceeded its fundamental-justified level by approximately
5 v4 \2 K% h1 p+ G! Y# S12%, an excess that was exaggerated in the past
three years.
By “overpricing” we mean that prices detached from
. H" D( G, F& @; q! a; Vtheir fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
6 y( H  V; h+ l+ Y, Q8 ~  Rboth a cyclical downturn and a return of house prices
to fundamentally justified levels.
5 c- z7 W, m6 ^% I: U, F6 J  gWe consider “overbuilding” of two forms: “demanddriven”
6 U- o1 o1 j4 pwhere homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
7 @& n  I1 N2 R“overbuilding” was mainly of the first type, where
' d2 h# c- m1 e: lhomebuyers pushed homebuilding to an unsustainable pitch
2 C3 Q3 m5 N# I& c3 nthat is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
8 ?6 e5 y1 A# s* Zthe construction of too many new homes over the boom
means a deepened slump. This overbuilding will likely weigh
  {- I( {( K* a! d0 @( c6 N# p4 x* l( [on markets over the next few years. Even as Canada recovers
from the cyclical downturn, house price growth will
( [: L: n# e- S9 Sremain choppy and new residential construction will be
: ?9 a7 s+ h; J5 i% S, S8 f8 \dampened, 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
; Y4 b- w$ }) A125,000 starts over 2009 with a trough around 115,000 units
& o) {+ ^( D, i/ Y" }0 U% d( @in the fourth quarter.
; o! X! C3 h) NTo quantify the degree of overpricing and overbuilding,
5 p5 c8 U# M, r& awe first develop an empirical model, based on long-run
4 h; c3 B! M) ~" @# d( {fundamentals of house prices and housing starts in each
1 O$ q! s. ^% p8 ]( y. A/ A# }province. Affordability is the key concept behind home
values since house prices should track incomes over the
long-run. Since homebuilders build to meet demand, we
regard housing prices and household formation as the drivers
. A2 S# D$ j/ L/ _% ~) M/ kof residential construction.
+ Z9 B  z* b1 p, S8 O, T/ g- lTo examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
- o0 B" a  W3 A2 _2 D! {) Z: Roptimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
9 `' O) D- C8 E/ munits were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
2 p. g0 s, u5 T  x3 Wwhere housing demand will further contract under waning
4 L' n0 Y7 e- X: q# C0 u' O; Mpopulation inflows. Saskatoon, Calgary and Edmonton are
& ?! u: E  k0 @) r, p+ e( I3 aalready 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
; ~$ v4 Y& ^: j3 w% U* J8 c) vweakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
strange accumulation of unabsorbed multiples on l’Île de
  o1 w  [2 P4 U+ ~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
) ]  p# L: \6 }' X: |* c6 mcyclical downturn, the degree of structural weakness appears
4 ]' D8 {8 e4 P- x1 H* m* A4 Jlimited – with the important exception of the Toronto
7 s+ ^) T) R; |  Q$ Bcondo market. Both in Toronto and Vancouver, historically
4 n) M6 J( j# P7 j6 \high levels of apartment-style units presently under
, d8 Y0 @$ b' o0 T6 _construction mean that record numbers of condos will
& R7 S- P* Z8 q- i. e' S+ nreach completion during 2009. If absorption rates fall, as
/ ^# {0 s; ^% D( I- xcyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
4 O3 z& z+ P7 C, j, _residential construction in B.C. will definitely droop, we
anticipate that the West Coast will continue to benefit from
( J8 J* O6 {6 Y7 yinter-provincial and international migration over the coming
years, which, along with improvements in affordability,
- m' R* ~6 |' f, o7 M7 S7 [will alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
# e5 q" ?  a- U4 n+ ?" v416-982-8063
Pascal Gauthier, Economist
, }' i: S: \& |# \416-944-5730
) L5 c4 g1 x. X( G
' a# {8 h& r; C" mhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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