TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
. A0 A! p1 i+ ]2 o$ a% ?, Ifrom 2002 to 2008, unsustainable price increases drove
unsustainable levels of building. Our view is that house
- K& I4 }1 C* Hprices exceeded the value of housing that was justified by
: b! t2 a( \  r9 ^$ F- ofundamentals by approximately 9% nationwide. This
3 r' L8 C) B4 s4 loverpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
three years.
4 d" O% B2 Y9 L- E8 O1 L4 p) VBy “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
+ w$ X( J7 H5 F5 d: waffordability. The current unwinding of house prices reflects
both a cyclical downturn and a return of house prices
to fundamentally justified levels.
4 Q% ?& _3 m1 i( O* {We consider “overbuilding” of two forms: “demanddriven”
- K; _& T7 c, [9 @0 ewhere homebuyers buy up too many houses and
9 B+ m- `4 j. Othat this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
. T  M( S+ }+ G, ^4 Q7 \9 X7 @, lthere is evidence of both types, we contend that Canada’s
. F+ A7 w: C5 A5 a: i3 U) p“overbuilding” was mainly of the first type, where
homebuyers 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
means a deepened slump. This overbuilding will likely weigh
+ |/ W( Z1 G* X1 k/ l- N9 m  `on markets over the next few years. Even as Canada recovers
from the cyclical downturn, house price growth will
6 q  ^; v  j8 n  a& D- \5 J9 qremain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
! X4 Z' y3 u+ p# @& W# C1 r# ?is 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
( `' ?# P1 r0 a- `3 i/ W8 Q+ s2 i0 @in the fourth quarter.
/ x6 P7 n! Q& z  q7 T4 D8 JTo quantify the degree of overpricing and overbuilding,
we first develop an empirical model, based on long-run
fundamentals of house prices and housing starts in each
" i. o- D6 s' i! @2 H; |$ cprovince. 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
regard housing prices and household formation as the drivers
: i9 f# ?$ o! o5 N5 q9 B# ~of residential construction.
7 \7 x3 y3 b) ^% V# Y! v$ o( L+ M6 p4 gTo examine the degree of overbuilding, we employ a
1 J3 l( J5 U- y; b. o0 W+ I“counter-factual,” asking what level of residential construction
# K' P% a+ u+ N. _1 K5 h# ywould have occurred if housing had been priced
* \! f8 x$ r" z  k. S( d5 t& E) moptimally. We find that actual homebuilding exceeded this
, S0 w' b- B) B) B, i* Y8 Ufundamental-justified level by about 12%. Although new
1 c! _, ]0 b( v: Punits were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
; v) x6 h( D2 @. y0 Z' Kwhere housing demand will further contract under waning
population 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
. Y: V/ W. I! J) xbuyers’ territory. Homebuilding in the Atlantic provinces
! ]4 g, M7 _. n4 I; uhas been relatively balanced but, while not plagued by structural
) Q4 h. L  f6 E7 Yweakness, will be singed by the downturn nonetheless.
7 \8 `3 g; w$ YQuébec shows signs of strain – especially given the
0 V8 O/ S. Y2 h6 L1 {! L3 L) Fstrange accumulation of unabsorbed multiples on l’Île de
Montréal – but recent building has been relatively balanced,
/ a6 ~* J/ v) V  n0 tgiven the province’s history of under-building and low ownership
4 M7 I$ n1 m6 z0 vrates. 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
& P. M+ e2 r& q3 Z; i2 l  zreach completion during 2009. If absorption rates fall, as
, k# v4 S9 [5 q+ {cyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
residential construction in B.C. will definitely droop, we
% _0 D. I1 ^5 B! t9 Y& l9 I$ Fanticipate that the West Coast will continue to benefit from
; b$ l1 H) ~" z( h* ?; \' Einter-provincial and international migration over the coming
years, which, along with improvements in affordability,
% c; ^" m5 B/ Ywill alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
9 h- }; D' x5 P# K. e+ mMARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
. F' ?$ x* `8 _3 g/ D9 _Pascal Gauthier, Economist
416-944-5730

1 s; \$ e3 O" l4 t% S8 Zhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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