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
& Z4 v" W: h. E# |1 l  @. X! lunsustainable levels of building. Our view is that house
prices exceeded the value of housing that was justified by
' w1 O. r9 {; P, {; ufundamentals by approximately 9% nationwide. This
  [& z, o1 J$ D8 S( woverpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
3 H0 v, U! Z0 b12%, an excess that was exaggerated in the past
1 n3 \  \% T+ j  jthree years.
+ E' f$ d* ]) q. x7 TBy “overpricing” we mean that prices detached from
3 o% Y4 k5 \7 vtheir fundamentals, as witnessed by a steep erosion of
$ p9 [) j3 }/ C) U# _# j6 d8 e, iaffordability. The current unwinding of house prices reflects
both a cyclical downturn and a return of house prices
to fundamentally justified levels.
! a$ q& B! u0 \/ V# x2 FWe consider “overbuilding” of two forms: “demanddriven”
) ?, }. h3 y4 ?where homebuyers buy up too many houses and
* K. n" i3 O" l6 R$ X8 S7 Fthat this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
! f! V, q) `+ y1 B6 t) j  a3 p% uthere is evidence of both types, we contend that Canada’s
5 X- S' [5 q. K& ]“overbuilding” was mainly of the first type, where
- g1 ^- l4 O! thomebuyers pushed homebuilding to an unsustainable pitch
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
6 m6 _. m) C' G. V( F: L" lmeans a deepened slump. This overbuilding will likely weigh
on markets over the next few years. Even as Canada recovers
$ s: L8 M1 F; afrom the cyclical downturn, house price growth will
1 g* _' _+ M" i; E" G1 m! r7 hremain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
2 z) }' Q4 r, m/ K4 s& {$ P! Pto persist over 2009 to 2011. We anticipate that nationwide
# _" v8 H2 w3 c9 ~residential construction will fall further to around
125,000 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
7 ?* [: G* I+ L0 a, Mfundamentals of house prices and housing starts in each
province. Affordability is the key concept behind home
4 [( A5 o5 ?* d7 F( W# e% t5 {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
of residential construction.
- v: ]- W' h" V) ?' pTo examine the degree of overbuilding, we employ a
! ^' K! O. ]3 ^1 v( Q“counter-factual,” asking what level of residential construction
/ t! g! g; {; g3 K! L. ?6 p/ q( xwould have occurred if housing had been priced
4 k, L+ R6 U7 C8 K, ^/ b: P: v: W$ yoptimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
5 [. _( R) C; J  Y* n" w# Munits were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
* u9 W0 u5 f* ?8 c( r5 s- {Regionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
* |( {/ H$ ~$ ~% T  ^5 y' b# Rvery time that the resale market has swung into strong
* K3 @5 r0 n9 Gbuyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
# L2 p) I$ u, k0 _9 M! ?weakness, will be singed by the downturn nonetheless.
& x8 O7 R( k( m4 A4 M- c- v5 Y4 MQuébec 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
rates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
7 Q; d- H$ z3 L3 c2 w5 R/ Xlimited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
. b; W7 a* s4 h, C( yconstruction mean that record numbers of condos will
7 G, q1 x* E* S% Zreach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
, J1 L& Y* F. ^spike severely – particularly in Vancouver. However, while
residential construction in B.C. will definitely droop, we
" q3 T, V, L: n; |  panticipate that the West Coast will continue to benefit from
% i+ g: |/ G1 {; h  _' E- u  [inter-provincial and international migration over the coming
, `' z8 I/ s5 i6 u/ ]* ^years, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
: w1 V3 Z% x, b9 D- x4 ~% ZOVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
Pascal Gauthier, Economist
  s7 H# b4 `6 H2 s+ _* t416-944-5730

# O0 N$ |) W: b5 nhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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