TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
/ h+ n  ]3 _. Y' l1 M0 V, dfrom 2002 to 2008, unsustainable price increases drove
+ R, w, i' Z) H" ^0 h( Y" P/ P2 m; \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
! H' C8 ^& u2 @  i* voverpricing compelled a level of residential construction
* t$ U  q$ ], O+ Kthat exceeded its fundamental-justified level by approximately
& ]1 d3 _$ S5 G3 V/ `12%, an excess that was exaggerated in the past
three years.
; w/ O4 ?. t' t2 j7 c" a% UBy “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
- X# i+ W  B  e/ M, Haffordability. The current unwinding of house prices reflects
3 P( s4 q8 C! T9 \% ]7 i& aboth a cyclical downturn and a return of house prices
- t# I4 O5 H3 V2 @2 A7 w1 A4 n) Pto fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
/ S; ~0 A/ t' A4 L+ G" l, wwhere homebuyers buy up too many houses and
" h7 d1 N8 ]- j& ~! g% y: Rthat this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
& H$ E) r1 \+ Q0 H4 Tthere is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
# X* M1 T6 q, Zhomebuyers pushed homebuilding to an unsustainable pitch
, Z0 {' J; ~" J) @% C+ ~$ ?& U! w5 ^that is now being rapidly reined in.
5 M4 r2 b" \5 X  W5 w+ _% V2 v  @/ xWhile most markets won’t face U.S.-style overhangs,
) U! c' [/ k8 H; R6 Othe construction of too many new homes over the boom
. U1 ?) R. ]% c+ e* ]" x7 Cmeans a deepened slump. This overbuilding will likely weigh
$ v* x3 k9 }% _/ j" Yon markets over the next few years. Even as Canada recovers
" ^4 t) k3 {% Wfrom the cyclical downturn, house price growth will
remain choppy and new residential construction will be
1 _1 \' `# ]: Jdampened, 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
( H/ v4 r) O- E* z125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
To quantify the degree of overpricing and overbuilding,
we first develop an empirical model, based on long-run
' }% P( n# E* Xfundamentals of house prices and housing starts in each
. r) M2 q3 r! [) j" ^4 X2 g+ oprovince. 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
! F: S7 f. U0 Z6 ^4 tof residential construction.
To examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
6 u3 v3 n, u$ l/ lfundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
- N5 N" [2 l  k" |9 pwhere housing demand will further contract under waning
% [, _! U" `, S. S2 Hpopulation inflows. Saskatoon, Calgary and Edmonton are
" _! l/ d' Q+ c- f3 M5 l' w) Zalready witnessing surges in their unsold new homes at the
+ |7 ^" @2 t  n) w- o# Z/ z1 |very time that the resale market has swung into strong
buyers’ territory. Homebuilding in the Atlantic provinces
. e% t* i" F: nhas 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
. \3 x$ R' E7 L8 a+ |  Jrates. While Ontario homebuilding will reel from a
+ S7 s0 Q8 t! [- N; S! Gcyclical downturn, the degree of structural weakness appears
& ]6 n, _- P/ t+ x: t5 Flimited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
0 O6 r" e3 n  F* q) b. sconstruction mean that record numbers of condos will
) b& P# w4 l% b. Z1 l& ureach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
: x% s6 N9 `% a4 T+ X5 gresidential construction in B.C. will definitely droop, we
anticipate that the West Coast will continue to benefit from
inter-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
# H- I7 _5 F5 _  I7 X+ }MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
% d0 B/ \- o! W) ?( k/ H4 HPascal Gauthier, Economist
4 d9 ?0 B2 p/ z  _# f  L) c+ n7 }8 _/ Y416-944-5730

" l$ f' R3 J4 R$ H# hhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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