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
unsustainable levels of building. Our view is that house
) v* Z; D/ e$ d6 ~7 {. `prices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
$ |1 H9 g. H8 f8 c# n2 C% {% r; eoverpricing compelled a level of residential construction
, n- U1 n. Z' E. i5 w. Wthat exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
three years.
3 U1 k1 K4 v, WBy “overpricing” we mean that prices detached from
* e& n% X: d3 ~, atheir fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
  Q& p: H: D9 Z- H+ U% zboth a cyclical downturn and a return of house prices
to fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
. D% n3 e" J+ G$ s+ J7 k8 }where homebuyers buy up too many houses and
* d8 k' @5 S. L$ pthat 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
1 @4 h+ p$ n" I“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
, Y& c7 V9 }! Bthat is now being rapidly reined in.
) Q! Y; t3 k8 t9 IWhile most markets won’t face U.S.-style overhangs,
the construction of too many new homes over the boom
0 b: w/ i+ ?8 ?! `means 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
, J2 p4 m# Y) A" nremain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
+ G8 I; o0 ?9 gis now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
residential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
$ {0 o% D! R7 f4 ^To quantify the degree of overpricing and overbuilding,
4 C8 X8 [6 s  H" _we 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
" L5 X; t" T, r- W7 Qvalues since house prices should track incomes over the
long-run. Since homebuilders build to meet demand, we
- t+ J0 _  A: j, p0 xregard housing prices and household formation as the drivers
' F7 g1 Y0 j$ y) \of residential construction.
! \' F' f2 h( M( Z! w* rTo examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
9 ]* @0 o1 A- l8 S) @# h( |would have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
fundamental-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,
where housing demand will further contract under waning
0 J, G! n, F. S( U. u+ T& l8 mpopulation 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
, `6 q) p& ~% ibuyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
% p5 N5 J. h; ~( j  E( Zweakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
9 G3 ^& U' y$ Ustrange accumulation of unabsorbed multiples on l’Île de
Montréal – but recent building has been relatively balanced,
0 i* M7 r% F5 h+ m- y9 Kgiven the province’s history of under-building and low ownership
9 `: L2 a: }6 R: ~1 x9 I" Z' Rrates. While Ontario homebuilding will reel from a
( T5 B* C1 e" Icyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
construction mean that record numbers of condos will
. e5 H+ w; x" Lreach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
0 E# [! F3 |. @1 C0 nresidential construction in B.C. will definitely droop, we
5 {6 [/ @5 }$ t, X9 K; Santicipate that the West Coast will continue to benefit from
inter-provincial and international migration over the coming
) h3 B  B$ x, U9 o- V) ?! Qyears, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
6 B3 F6 l; _( qGrant Bishop, Economist
$ m  ^  R/ _0 ]" [416-982-8063
- d. ]- S7 j& v6 [- _/ ]5 l" hPascal Gauthier, Economist
3 {9 m1 ?* E, W5 i416-944-5730
( |- J1 N5 s1 z4 q8 S) k6 @
9 y# _' p* ^- I# J6 k1 Z9 C% B; k  L" Ghttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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