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
/ Y8 g, U) J+ M  F/ w; `prices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
8 ?5 ], G8 Y% K! c( f4 toverpricing compelled a level of residential construction
# `) J" Y/ C8 E% _, P1 Wthat exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
three years.
: v6 U( P. z5 z, X" ZBy “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
0 X1 S! ~0 @9 |* _3 S' c5 m+ U+ oboth a cyclical downturn and a return of house prices
to fundamentally justified levels.
" K9 x" a  W0 t0 o" g6 F* \We consider “overbuilding” of two forms: “demanddriven”
7 y* V3 K! x4 _0 I' Uwhere homebuyers buy up too many houses and
% e+ o. V# ^) N/ x3 X1 x" Ithat this demand cannot be sustained; and “supply-driven”
: S  z6 u% e6 c& b. bwhere builders accumulate excessive inventories. Although
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
& Y$ d" J' E1 \that is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
the construction of too many new homes over the boom
means a deepened slump. This overbuilding will likely weigh
$ U* L" [$ @" }# aon markets over the next few years. Even as Canada recovers
' j4 Y- s7 m! c0 w5 v; n& M0 [) `from the cyclical downturn, house price growth will
remain choppy and new residential construction will be
$ K5 {8 U8 k4 B  Adampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
8 U$ A- h* s3 ]& X4 Y; P2 fto persist over 2009 to 2011. We anticipate that nationwide
residential construction will fall further to around
: ~& `9 t5 B0 t% k125,000 starts over 2009 with a trough around 115,000 units
1 x0 Z; k" u5 vin the fourth quarter.
To quantify the degree of overpricing and overbuilding,
' S7 b% G/ O- m% q/ w7 kwe first develop an empirical model, based on long-run
, e5 D9 m2 j$ y- U' n% w! g6 Cfundamentals of house prices and housing starts in each
province. Affordability is the key concept behind home
: q' p$ \3 [; ^/ V9 X0 |values since house prices should track incomes over the
2 X" q+ [* D5 d% olong-run. Since homebuilders build to meet demand, we
regard housing prices and household formation as the drivers
of 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
fundamental-justified level by about 12%. Although new
, W7 T0 k; v. h$ {0 Bunits were being absorbed, homebuyers simply bought too
# O5 V; ]) H1 \) v- V; q  Imany houses at prices that exceeded fundamentals.
; S3 \: f6 Z: R' b. DRegionally, we see the greatest strains on the Prairies,
( D- W' D6 c0 y/ Awhere housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
/ ~& r  k! [( J5 l. x" A0 ~- k7 falready witnessing surges in their unsold new homes at the
very time that the resale market has swung into strong
; _" x0 l$ x) F( e1 mbuyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
9 o  q" p2 I+ g& q5 {: h5 Rweakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
+ U+ B9 O: R) A' [3 Nstrange 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
6 `) `: x; Q4 ]4 frates. While Ontario homebuilding will reel from a
/ i* q- u! l* u  L  Fcyclical downturn, the degree of structural weakness appears
+ F  y5 c* E1 J7 d. L( Zlimited – 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
% Q# C, G4 m$ A  z% p  h/ b# X  {- treach completion during 2009. If absorption rates fall, as
0 w' A3 Z4 [0 J' e/ ?. {3 Kcyclical factors would indicate, condo inventories could
; v6 K# }, a  U& Espike 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
. T8 Y6 T. y1 y- f% a& D$ I: ^% jinter-provincial and international migration over the coming
+ U4 Q$ i2 N* O- E% X2 ^/ [- r, dyears, which, along with improvements in affordability,
* q9 {; I( w3 }  L2 Swill alleviate some of the pressure from overbuilding.
/ ?8 l7 E: J, M6 f( ?+ L$ i6 ~OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
Pascal Gauthier, Economist
416-944-5730
& B* j! y6 v4 k6 g
  Y* P: ?% t9 X& b0 a' B0 \http://www.td.com/economics/special/gb0409_housing_exec.pdf

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