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
$ F" U* h* Z! F+ c& N( \& E- Bprices exceeded the value of housing that was justified by
( R; U9 |* o  P+ N6 }! R9 A3 [2 ~fundamentals by approximately 9% nationwide. This
7 O/ W( r9 E8 C( J3 e7 soverpricing compelled a level of residential construction
8 x. h3 L! C8 t- Pthat exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
three years.
By “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
# Y4 T7 R4 e" b* ?affordability. The current unwinding of house prices reflects
both a cyclical downturn and a return of house prices
+ W" {  o+ B) oto fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
% v" J1 J, X1 D3 c6 {- q& y% [" hwhere homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
4 Z, V: K/ ^+ t* Wthere is evidence of both types, we contend that Canada’s
% f- }& x4 i- S/ S“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
& M  v0 |& }( C( _8 K" D6 ]0 h. uthat 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
) f" \; d2 z$ k( x$ ?6 lmeans 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
" J5 Y, u4 Z6 X& j% n% P+ ?remain choppy and new residential construction will be
; s$ \6 E( ]* ^. n# edampened, owing to this structural weakness. Construction
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
in the fourth quarter.
! Q% G" F  w. sTo quantify the degree of overpricing and overbuilding,
7 ]4 q# l4 T" ?2 b1 w; Dwe 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
% k; `- g: z$ v1 vvalues since house prices should track incomes over the
6 q& c6 R8 b% `! X8 a0 w# @long-run. Since homebuilders build to meet demand, we
regard housing prices and household formation as the drivers
; U( `8 @# g4 a) Eof residential construction.
To examine the degree of overbuilding, we employ a
/ \4 M6 K4 ?, F0 m“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
7 Y1 ^7 |0 Q9 x4 [7 O" koptimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
7 J! K, u4 O2 kunits were being absorbed, homebuyers simply bought too
; g. M6 Y/ a9 F- smany houses at prices that exceeded fundamentals.
$ z; j% _/ y6 ~* Y$ f% jRegionally, we see the greatest strains on the Prairies,
9 g4 ~( f0 i2 R& H3 F! O9 }4 {where housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
* d- c' Y2 N4 e. l8 Zalready witnessing surges in their unsold new homes at the
: N1 n1 M1 {. S: C0 p; L* Kvery time that the resale market has swung into strong
8 N* C+ i; t" C( Abuyers’ territory. Homebuilding in the Atlantic provinces
  a% b; W8 }7 q: G, B7 B2 Ahas been relatively balanced but, while not plagued by structural
weakness, will be singed by the downturn nonetheless.
' W% p$ ~  I) ]8 T% KQuébec shows signs of strain – especially given the
strange accumulation of unabsorbed multiples on l’Île de
, o# c- f$ E2 F5 GMontréal – 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
limited – with the important exception of the Toronto
  R% ^. B3 c% K3 _# Xcondo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
' g$ W/ s. Q6 _" L+ cconstruction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
$ Y7 j3 a6 T9 t, x; q" O  d  fcyclical factors would indicate, condo inventories could
6 Q; E: \9 _8 ~8 j* K, Mspike severely – particularly in Vancouver. However, while
$ ?8 t% F# v0 V/ O6 m( Zresidential construction in B.C. will definitely droop, we
. a8 t: r6 D; p: J+ u+ H, Zanticipate that the West Coast will continue to benefit from
4 Y' }6 O1 J4 vinter-provincial and international migration over the coming
3 q2 _" G. G7 qyears, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
* B$ J! e% b% F+ I4 ^- _: N6 aOVERPRICED AND OVERBUILT: CANADIAN HOUSING
% [2 a+ p9 @: h/ A# l# qMARKET RETURNS TO FUNDAMENTALS
# n' a& ?8 H( Y9 AGrant Bishop, Economist
416-982-8063
" o  |) u5 q, g) l+ kPascal Gauthier, Economist
, s/ ~. ^9 |* A1 L' X8 ]416-944-5730
1 C0 m) J% x* A% g% A; R
- A3 m: r3 i  ]/ J" y$ Thttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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