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
) j: ?/ O( O& c4 k: u3 z  V" Munsustainable levels of building. Our view is that house
prices exceeded the value of housing that was justified by
3 v9 h  R) H, {7 N* A3 W& Gfundamentals by approximately 9% nationwide. This
' k6 S3 b: r, J8 t3 {! g1 Eoverpricing compelled a level of residential construction
2 ^+ e* b. |7 ?' h/ M8 _that exceeded its fundamental-justified level by approximately
4 U: H6 U/ F. y8 W- ~( N& W12%, an excess that was exaggerated in the past
* @* Y- ~; B6 A7 zthree years.
* @- r2 z' H& IBy “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
7 n) I% x# Y, A* z+ i# @. oboth a cyclical downturn and a return of house prices
0 q; C  A: R' N* {; \to 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
6 z, ~, A  X- [  p, }) ithere is evidence of both types, we contend that Canada’s
" z' Y( f% T6 i+ u“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
$ {: j! ?" G; J6 o( w' q% {4 yWhile most markets won’t face U.S.-style overhangs,
the construction of too many new homes over the boom
/ k! T$ ?4 N7 k& Tmeans a deepened slump. This overbuilding will likely weigh
on markets over the next few years. Even as Canada recovers
from the cyclical downturn, house price growth will
- ?2 ~3 g6 J3 m* K7 W- Y( B3 H5 Kremain choppy and new residential construction will be
! d4 ?  d& N5 h3 i+ k) U5 Ndampened, owing to this structural weakness. Construction
- \  W, `( L2 `6 n, mis now undershooting fundamentals and we expect this
; N9 {# T6 ]: K8 P8 uto persist over 2009 to 2011. We anticipate that nationwide
* D6 F. S3 g+ H3 N. u( |residential construction will fall further to around
4 m- k+ F) J8 S# ?: B125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
To quantify the degree of overpricing and overbuilding,
4 i% U0 p2 I7 w- ]- Bwe first develop an empirical model, based on long-run
) K/ Z5 E+ u$ W1 mfundamentals 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
long-run. Since homebuilders build to meet demand, we
( s; k4 y& g" E9 O7 R" y6 ]7 Xregard housing prices and household formation as the drivers
of residential construction.
To examine the degree of overbuilding, we employ a
" T& H* t% P* M2 y7 L& v“counter-factual,” asking what level of residential construction
1 h5 `% }* t8 [7 m" }; Lwould have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
$ c4 c0 P& y' A* U# N4 ofundamental-justified level by about 12%. Although new
% A4 K: B2 _1 d8 e# Bunits were being absorbed, homebuyers simply bought too
& ?4 L4 b3 u& \0 X0 C) a" t# ?many houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
" {/ N. x$ P# k4 a0 Cwhere housing demand will further contract under waning
9 ^/ ~  l( ~& z7 ^4 n, ppopulation inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
6 @' k' U- r% H/ [: G3 P+ R- Cvery time that the resale market has swung into strong
1 {/ ^9 j4 {, ^' E% f, Bbuyers’ territory. Homebuilding in the Atlantic provinces
- ]% Z& T. }8 C! Z3 ahas been relatively balanced but, while not plagued by structural
4 o8 W. ?8 {0 U: t2 Bweakness, will be singed by the downturn nonetheless.
2 R1 }# S. ~4 N$ sQuébec shows signs of strain – especially given the
; X2 t! H) j8 A3 D# ?6 [strange accumulation of unabsorbed multiples on l’Île de
2 x5 Z% H5 [& LMontréal – 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
6 N" x  M- q% i+ e* Lcyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
  _" ?4 t! |4 X6 u& b3 u; i  `condo market. Both in Toronto and Vancouver, historically
$ p$ m- y6 x1 g& m- ~8 H6 thigh levels of apartment-style units presently under
3 B  y/ ?+ J" J7 Fconstruction mean that record numbers of condos will
/ a. Z* J  v. r+ F3 m# I" |6 vreach completion during 2009. If absorption rates fall, as
& Q' v) `$ N- G. p& P4 H0 n1 Acyclical factors would indicate, condo inventories could
$ P: X; Q0 O/ W0 z6 o1 ~spike severely – particularly in Vancouver. However, while
residential construction in B.C. will definitely droop, we
anticipate that the West Coast will continue to benefit from
9 `6 f1 e. _2 Sinter-provincial and international migration over the coming
years, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
1 p$ `! e9 K2 POVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
+ r+ Z" ^: N" [- D' {4 [# d' \& m416-982-8063
' j! _# B- B4 W! jPascal Gauthier, Economist
% H. M; O+ g" N/ e416-944-5730
  {! H) c1 ?1 Q$ r7 w
2 |. D7 a" P# }% lhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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