TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
0 b$ A1 F5 `0 {/ @. b5 M8 dfrom 2002 to 2008, unsustainable price increases drove
8 @/ o( v! s* c* M* sunsustainable 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
that exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
2 [+ |; N/ A9 k# q0 X2 \2 P. Y; Wthree years.
# }6 {' l+ I# s6 }4 ?By “overpricing” we mean that prices detached from
6 u2 W. \+ f# e8 B, V; ]their fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
0 U1 i. Z* K% v, wboth a cyclical downturn and a return of house prices
to fundamentally justified levels.
5 h6 Z$ n8 H6 g5 X  M+ T3 {- VWe consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
2 J" F$ H( {* Qthat this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
/ v6 p' K& i8 x: b  Tthere is evidence of both types, we contend that Canada’s
" _/ O* t: p6 d“overbuilding” was mainly of the first type, where
% @: n- w  T8 E- U! Phomebuyers 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
1 s. U* w0 Q, Mmeans a deepened slump. This overbuilding will likely weigh
on markets over the next few years. Even as Canada recovers
0 _: M" z8 v3 z- efrom the cyclical downturn, house price growth will
remain choppy and new residential construction will be
) H. f6 c0 E5 _# _5 r+ Odampened, owing to this structural weakness. Construction
, z: [# [  U3 |3 G% z, Dis now undershooting fundamentals and we expect this
4 Q, W9 C1 n: R, u" tto persist over 2009 to 2011. We anticipate that nationwide
" \+ B9 \( k0 c/ eresidential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
% N7 i& w8 [( r: k" h+ r" uTo quantify the degree of overpricing and overbuilding,
we first develop an empirical model, based on long-run
% F* N9 A/ `& K! D+ `6 z, ufundamentals of house prices and housing starts in each
+ p3 T) Q" c3 J2 L, w( ^' C2 M  Xprovince. Affordability is the key concept behind home
+ t$ D2 A* ]2 e- Dvalues since house prices should track incomes over the
/ {% }! [) r( l- `6 F4 p3 glong-run. Since homebuilders build to meet demand, we
8 f) o& w8 u8 H: Z4 k, Q) Dregard housing prices and household formation as the drivers
+ s- u2 z3 W6 j; N' A9 @" Y" b% Wof residential construction.
To examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
4 d, y/ D6 c+ V) [- xwould have occurred if housing had been priced
+ Y+ m# ^  n$ r* L: Joptimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
9 W% c% N- _% F7 J! hunits were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
& W4 A: |% V+ }: Salready witnessing surges in their unsold new homes at the
very time that the resale market has swung into strong
$ a* S3 J0 g; J/ ~buyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
( \* @% c& y' _( g  kweakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
$ R: O$ l9 {' e- H! e  i1 astrange accumulation of unabsorbed multiples on l’Île de
% a9 C' B4 V5 {" I% e8 Q' oMontréal – but recent building has been relatively balanced,
5 V' d5 Y5 |, i2 C/ r1 d8 j, b5 Dgiven the province’s history of under-building and low ownership
* }/ N$ i* P( O; F! |rates. While Ontario homebuilding will reel from a
) S  u2 |8 {& g$ f) o' ~- f! F* b: |cyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
( v+ ^% E, B% b" `0 ?; Hhigh levels of apartment-style units presently under
construction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
1 N6 _+ W0 E# a, B! g" Ncyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
7 U# G, _' c+ jresidential construction in B.C. will definitely droop, we
anticipate that the West Coast will continue to benefit from
0 h3 {' _' l/ g' n2 ginter-provincial and international migration over the coming
years, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
( z/ G1 j( ]" |/ jMARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
Pascal Gauthier, Economist
3 R5 B1 t4 q6 G416-944-5730

" D& L# V$ W* ^9 o( {3 ahttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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