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
9 d" i; _, G/ n  Lunsustainable levels of building. Our view is that house
prices exceeded the value of housing that was justified by
6 ~% @. X4 }- j' G2 C) Y' ?fundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
! F3 y$ W) j$ gthat exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
three years.
: U/ b/ N; ^- ?- T8 ?7 pBy “overpricing” we mean that prices detached from
: B, k3 _8 E9 W- R$ }2 ^their 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
' {, M3 i' d6 K9 y# Hto fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
' a; ~2 |. R4 W) ]there is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
8 \( O# C0 z1 R3 Lthat is now being rapidly reined in.
3 h2 C/ x) Z: |4 ZWhile most markets won’t face U.S.-style overhangs,
6 r4 }4 c6 Z! \7 Sthe construction of too many new homes over the boom
means a deepened slump. This overbuilding will likely weigh
8 \' O; K4 @* f7 h: 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
; O. |( z* a9 ]dampened, owing to this structural weakness. Construction
* \, V. |& c! f5 y/ D& g. \8 xis now undershooting fundamentals and we expect this
+ P' k0 Q3 J8 ^1 r; m1 W- ~to persist over 2009 to 2011. We anticipate that nationwide
residential construction will fall further to around
! _; X2 N, \1 S; u+ m125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
  U3 q2 H# _8 K! d( U; C4 y& PTo quantify the degree of overpricing and overbuilding,
: o+ g; n6 `- {$ o( E% Kwe 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
values since house prices should track incomes over the
" b5 U$ s7 n. A& p- Klong-run. Since homebuilders build to meet demand, we
0 q' K, d" N6 l; oregard housing prices and household formation as the drivers
of residential construction.
7 P& T4 ?8 v* D2 b! R0 D8 gTo examine the degree of overbuilding, we employ a
- H% B* w3 F. d: y+ i7 e$ W“counter-factual,” asking what level of residential construction
7 {6 I% N7 [+ l2 V: u1 {  awould have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
- d9 q. r" z7 i- L, J$ D7 Bfundamental-justified level by about 12%. Although new
# E0 d" D; a) y2 i+ q1 nunits were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
0 d" W+ G, D. h# t; vpopulation 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
3 u$ _0 s- W% T) x2 G7 Jbuyers’ territory. Homebuilding in the Atlantic provinces
3 R/ N6 n' a& a( k' o( \; Fhas been relatively balanced but, while not plagued by structural
weakness, will be singed by the downturn nonetheless.
; I6 _1 J0 s: f: ~- x. a/ FQuébec shows signs of strain – especially given the
; Z# |& G% d! g( b/ h. P- I  o" vstrange accumulation of unabsorbed multiples on l’Île de
( M3 z6 d: _' V( q* ~Montréal – but recent building has been relatively balanced,
) ?& ^; G7 ~2 P  M2 w6 Vgiven the province’s history of under-building and low ownership
  H- `/ A. [8 a/ |. d  Y5 _rates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
, I7 d' {9 N3 hcondo market. Both in Toronto and Vancouver, historically
3 R, R* t9 x$ B- ]& ?high levels of apartment-style units presently under
- F7 p+ p/ A4 |construction mean that record numbers of condos will
+ T, A4 ]3 A9 z4 r  D7 A, y6 H* |1 sreach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
) k7 N8 s; x; f& g. I: n+ a6 |$ l1 Sspike severely – particularly in Vancouver. However, while
residential construction in B.C. will definitely droop, we
( d. H9 \+ \) h/ _* a( {0 @anticipate that the West Coast will continue to benefit from
; n% n0 \" d& G- w- ?- Y0 @inter-provincial and international migration over the coming
1 m% F. s. |; P% cyears, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
# Z* C7 [1 z! d' r) uOVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
3 d6 u& f0 Y: N6 p8 W# Y416-982-8063
Pascal Gauthier, Economist
416-944-5730

, e0 N+ X+ |7 Bhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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