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
! o% x# K$ F- i: q1 D1 y: Yunsustainable levels of building. Our view is that house
prices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
& d8 O, h3 h3 p) I# Tthat exceeded its fundamental-justified level by approximately
( q- ]0 P# ?) R% O# i$ U8 I12%, an excess that was exaggerated in the past
* \* m, R; c" O" uthree years.
By “overpricing” we mean that prices detached from
% f4 d$ R3 b% [* P! u4 P1 {! Itheir fundamentals, as witnessed by a steep erosion of
$ [8 s- [; p+ b/ ?; F, m1 h, ~affordability. The current unwinding of house prices reflects
8 Y2 x  F: F- A# @4 L, w/ oboth a cyclical downturn and a return of house prices
! U8 U( Z2 O& U, n, xto fundamentally justified levels.
, Y+ p* j' ^. Z5 ~; |4 x7 iWe consider “overbuilding” of two forms: “demanddriven”
6 W3 [( c5 H+ b+ Xwhere homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
0 z7 |5 ^: n3 c3 Ywhere builders accumulate excessive inventories. Although
; w5 b8 v* D0 n# i5 n# p7 a! bthere 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
that is now being rapidly reined in.
3 ~% S/ s0 d) C5 g# w0 _While most markets won’t face U.S.-style overhangs,
/ A- z: `4 w3 z0 V1 J/ x- P+ Sthe construction of too many new homes over the boom
means a deepened slump. This overbuilding will likely weigh
on markets over the next few years. Even as Canada recovers
! _- A2 T, |* mfrom the cyclical downturn, house price growth will
7 z2 o2 `. z6 b3 c2 }0 ~remain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
1 |- N; y1 n) E! F8 F) Uis 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
% S$ q4 Z6 t6 G% {# P2 R/ Z9 Y) _in the fourth quarter.
# K, I8 G; G) ?- S0 F4 p  yTo quantify the degree of overpricing and overbuilding,
we first develop an empirical model, based on long-run
5 J$ M  P1 |; W3 E. cfundamentals of house prices and housing starts in each
province. Affordability is the key concept behind home
4 x( h7 a1 [; H4 g6 E) `: `values since house prices should track incomes over the
4 j3 K2 P% F, a) F# Ylong-run. Since homebuilders build to meet demand, we
) w# P( l! r2 J4 pregard housing prices and household formation as the drivers
of residential construction.
) i+ Z! Q+ o* [6 k" h# P. }To examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
& G+ s" D3 b, R+ Ywould 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
! k6 q5 R( ~$ Ymany houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
  a& ?: j4 Z8 [% ?1 U# F$ t0 U$ ]8 owhere housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
- }) ]+ v- m( q2 y0 galready witnessing surges in their unsold new homes at the
7 n) c# Z& K5 o' t% K) F+ ^; Bvery 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
weakness, will be singed by the downturn nonetheless.
' h- b  T3 \9 T- ?) l) HQuébec shows signs of strain – especially given the
' Q2 A9 o; {0 `6 fstrange 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
; e/ D8 C* q3 Z4 n& B1 ~  trates. While Ontario homebuilding will reel from a
cyclical 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
4 q6 h  Q8 |) @' q/ ~* ^reach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
8 i" z6 Y4 C: Z1 m$ _spike severely – particularly in Vancouver. However, while
$ V& Z- J2 J; s6 T- D; J6 gresidential construction in B.C. will definitely droop, we
( h3 C$ w' }/ M, z' Aanticipate 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.
0 K. J5 X! p5 f2 N& xOVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
2 Y4 W+ N5 Z, M$ PGrant Bishop, Economist
416-982-8063
Pascal Gauthier, Economist
! X2 P: F+ _" w1 a416-944-5730
, K+ v  m( T/ V) r- q
" |# ]% M# Z6 T0 x& B3 N' Q+ G8 nhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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