TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
$ x1 L# X; o$ f# J0 o) kfrom 2002 to 2008, unsustainable price increases drove
unsustainable levels of building. Our view is that house
prices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
0 h- t$ a" s6 mthat exceeded its fundamental-justified level by approximately
7 |- X! D9 D+ P  t0 p12%, an excess that was exaggerated in the past
; ?% F+ Z5 G: ?  H% b3 Ithree years.
6 ^: ?4 x3 |0 n% @By “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
7 q/ n& X+ Y! C$ y6 v% {+ [: maffordability. The current unwinding of house prices reflects
both a cyclical downturn and a return of house prices
to fundamentally justified levels.
- L6 h: b! o8 ~0 w8 ]2 d2 C) jWe consider “overbuilding” of two forms: “demanddriven”
: x& {4 M7 x: ~( Bwhere homebuyers buy up too many houses and
  h9 \5 s9 y; uthat this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
7 |( O# L# m% g# u' C% Wthere is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
6 x- E7 z/ P& z( R# H* a2 C! Dhomebuyers pushed homebuilding to an unsustainable pitch
% c9 f( ^0 ]6 Q, {) _/ E3 Kthat 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
4 c- H1 F* v( g9 c( y% f: _means 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
remain choppy and new residential construction will be
, {  C' R, u, {( y& kdampened, owing to this structural weakness. Construction
  V+ |7 x* M! Lis now undershooting fundamentals and we expect this
) z0 G- ]  r* F3 m5 Zto persist over 2009 to 2011. We anticipate that nationwide
  ?: h# v) O# D- \0 e- e3 Oresidential construction will fall further to around
$ i, E: ?* h1 v125,000 starts over 2009 with a trough around 115,000 units
- {# s1 Z* d; ]% ~! p# n, zin the fourth quarter.
To quantify the degree of overpricing and overbuilding,
5 [, k( X9 S4 |8 W" Z$ bwe 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
values since house prices should track incomes over the
) ]3 X8 O" |- ]4 ~long-run. Since homebuilders build to meet demand, we
regard housing prices and household formation as the drivers
& l8 X2 v  W0 k" j# bof residential construction.
To examine the degree of overbuilding, we employ a
  l  o/ N/ W( U“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
( A+ }- V1 ^; Q2 n$ ?( goptimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
8 l, [$ @: ~& {$ H) g( D/ _) Gunits were being absorbed, homebuyers simply bought too
: t2 q  C2 F- ]many houses at prices that exceeded fundamentals.
% s3 m  V1 y; K0 |! Z9 ~& \Regionally, we see the greatest strains on the Prairies,
+ B4 s1 ^/ X! Y2 d- l" T% J% ^3 _where housing demand will further contract under waning
: o# J. `& g7 s5 \( bpopulation inflows. Saskatoon, Calgary and Edmonton are
. R2 b4 Y- r% u3 p3 Ualready witnessing surges in their unsold new homes at the
4 Q; g& j- L9 J! A' o0 L! d, Ivery time that the resale market has swung into strong
! q' X1 ]+ w* n! Y* O* fbuyers’ territory. Homebuilding in the Atlantic provinces
' N0 _2 U7 M4 S& ^7 mhas been relatively balanced but, while not plagued by structural
weakness, will be singed by the downturn nonetheless.
9 R7 U! x1 a8 P8 w( `Québec shows signs of strain – especially given the
: N  @* i, p' t2 D7 bstrange accumulation of unabsorbed multiples on l’Île de
2 \, M7 b2 Z+ L  E& sMontréal – but recent building has been relatively balanced,
9 y0 E3 o. e) |) l7 [& L0 o5 I1 F/ Mgiven the province’s history of under-building and low ownership
4 d" I8 \5 H# A# x* e- Yrates. While Ontario homebuilding will reel from a
+ M& H; {6 C  U  L" F; K6 ^cyclical downturn, the degree of structural weakness appears
1 B3 C4 h" a% {limited – with the important exception of the Toronto
/ w: c, O& s9 j3 u% y  Wcondo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
2 K% g2 s, {) B. Bconstruction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
* S% w: X4 t& E# w9 V6 a' fcyclical factors would indicate, condo inventories could
$ p( }5 Y1 n$ _8 e: D! d: 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
3 ~" ~, p% H+ y5 k* {0 Binter-provincial and international migration over the coming
years, which, along with improvements in affordability,
/ p2 c  B1 o/ ?5 Awill alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
- T9 V5 S. M6 ^  S& {& ~1 J: ]416-982-8063
Pascal Gauthier, Economist
416-944-5730

: H! Z9 Z7 x2 v* a# rhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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