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
1 N% W+ U$ |2 a$ K- Munsustainable levels of building. Our view is that house
( q# U# x' a# a# E7 T. gprices exceeded the value of housing that was justified by
) |- n( \% d9 Tfundamentals by approximately 9% nationwide. This
+ A/ T3 ~- |5 E( L* g9 Noverpricing compelled a level of residential construction
( Y2 q6 W- a$ a' D2 F  {' Fthat exceeded its fundamental-justified level by approximately
" V7 a5 d( D4 {# Y12%, an excess that was exaggerated in the past
7 H/ h( A8 h/ j5 @1 y0 zthree years.
By “overpricing” we mean that prices detached from
' H0 S* B8 M% O$ g% w; A& F& Jtheir fundamentals, as witnessed by a steep erosion of
! i( ~# m8 n( Yaffordability. The current unwinding of house prices reflects
2 ?/ Y& ~) R5 d3 K9 Q4 J  N* Bboth a cyclical downturn and a return of house prices
- e# d, @( ^' d0 M% dto fundamentally justified levels.
$ g0 X" J0 @- }4 g  [- KWe consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
  y) g1 h* }+ W* b* othat this demand cannot be sustained; and “supply-driven”
5 \5 @3 Y4 E; Dwhere builders accumulate excessive inventories. Although
8 \2 n) w0 M& B$ G' ]) t1 h" lthere is evidence of both types, we contend that Canada’s
$ g1 W& c6 \" S9 P6 K% x) q; L, \/ Q( w“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
; r$ P! \1 ^7 Wthat is now being rapidly reined in.
9 U+ G' M+ d1 d. I5 g: N8 ]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
* ~) V) _9 `/ r3 Con markets over the next few years. Even as Canada recovers
from the cyclical downturn, house price growth will
7 x, ^. C" I- H, x% V- Y1 Bremain choppy and new residential construction will be
dampened, 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.
# `8 ?$ J# R1 N& \# Q: HTo quantify the degree of overpricing and overbuilding,
we first develop an empirical model, based on long-run
* Q9 m, n: [, w7 Bfundamentals of house prices and housing starts in each
province. 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
  B; |: \" I9 \regard housing prices and household formation as the drivers
" k2 k/ N# d: Y7 A! q6 }of residential construction.
8 v6 S4 ^" Y- w1 |, E. L- ^To examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
% }3 E3 s  `; S9 R/ kwould have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
5 H% e: Y5 [5 C/ ^8 p! H9 A* f- bfundamental-justified level by about 12%. Although new
# |" C) A0 f  T; x# O! a, Tunits were being absorbed, homebuyers simply bought too
$ }  n# i5 C/ a" u; Q  n" k: z- w- Ymany houses at prices that exceeded fundamentals.
: j: U2 I( y1 Z" w( k$ X" vRegionally, we see the greatest strains on the Prairies,
+ c8 }& i0 {% v0 rwhere housing demand will further contract under waning
. f# k7 ^7 {1 e' a: ~$ r. k/ ipopulation 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- e+ D5 \8 ]$ ^5 }9 dbuyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
1 f" L6 `# [( l& Q8 E/ Eweakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
. ?! X! B, O, c/ rstrange accumulation of unabsorbed multiples on l’Île de
0 b9 P5 v5 N* G- l. Y0 {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
/ {% o. ]' J3 ?" m/ o/ H2 c& Lcyclical 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
1 v0 g( N: o; r* I- xconstruction mean that record numbers of condos will
2 F, j, c: {1 \& x+ U. Yreach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
% {7 A9 W# v( i' K$ W, a- ^! R2 aresidential construction in B.C. will definitely droop, we
anticipate that the West Coast will continue to benefit from
inter-provincial and international migration over the coming
4 y; j/ h7 C2 i! `. s; E  p  M% Jyears, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
( J7 p5 T2 |* JOVERPRICED AND OVERBUILT: CANADIAN HOUSING
- B1 s9 x  }0 U- }9 s! BMARKET RETURNS TO FUNDAMENTALS
! V' \4 |  z  O9 M; {$ }/ TGrant Bishop, Economist
% n3 a# K2 C( d: f! F416-982-8063
Pascal Gauthier, Economist
416-944-5730
3 D9 a5 Q& T9 y! F; c2 a' s
( E$ h9 y! G; z  c  j0 z4 U# ahttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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