TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
6 z3 K- _! o6 O- {$ m9 m( mfrom 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
/ n: n7 h0 Z5 O, hthat exceeded its fundamental-justified level by approximately
* K+ W2 Z+ P  ]12%, an excess that was exaggerated in the past
$ S  T+ B- d' b( p$ r! _three years.
* Q( O" E& ]' g: C! J( nBy “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
! i& P0 w- W5 ^  k, T/ h. z& J% r: Paffordability. The current unwinding of house prices reflects
# ^- _& G. ~- U; ~! d* X% Bboth a cyclical downturn and a return of house prices
to fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
( |0 I, V% w) G- _0 ^. Mwhere homebuyers buy up too many houses and
; z( Q2 N. k; ~that this demand cannot be sustained; and “supply-driven”
4 T. g4 g" W) k/ Iwhere builders accumulate excessive inventories. Although
+ p' k( z2 q8 C- ~' qthere is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
4 ?8 R* Q2 d: N) B1 n- I1 X' ]homebuyers pushed homebuilding to an unsustainable pitch
6 Q$ y$ T( h7 P3 d, o6 Qthat is now being rapidly reined in.
% t) q3 k5 q/ jWhile most markets won’t face U.S.-style overhangs,
# T% k; X; n. P& B$ uthe construction of too many new homes over the boom
means a deepened slump. This overbuilding will likely weigh
+ I$ C* ^8 I2 O/ u4 S5 s, R* z% kon markets over the next few years. Even as Canada recovers
from the cyclical downturn, house price growth will
% y) E% r6 ]& g2 G, Bremain choppy and new residential construction will be
4 K8 a2 V  c0 [* k6 |  o+ K# e# Q. sdampened, owing to this structural weakness. Construction
' h" S( @3 R; v8 Qis now undershooting fundamentals and we expect this
2 z  C; r( D6 s& Y! `% x( @* kto persist over 2009 to 2011. We anticipate that nationwide
$ E& z3 v( C% d2 _5 B$ E2 {residential construction will fall further to around
7 ]9 @* W( ~" u. G+ t; _2 h125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
. o/ ?% v9 V+ k  mTo quantify the degree of overpricing and overbuilding,
: M% c  X% }( e: }we 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
: b. p. Q/ a8 o% D& t: slong-run. Since homebuilders build to meet demand, we
regard housing prices and household formation as the drivers
of residential construction.
To examine the degree of overbuilding, we employ a
# r2 c: p9 e2 h. j' F1 D9 p“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
4 P8 S1 ^2 g5 C6 t6 Z2 Zoptimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
1 o, ]: y+ P" Vunits 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
' Z% F3 b6 o5 Vpopulation inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
, Z+ o5 m  r7 @% Mvery time that the resale market has swung into strong
buyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
weakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
strange accumulation of unabsorbed multiples on l’Île de
6 h' s7 _- c' `9 h5 hMontréal – but recent building has been relatively balanced,
given the province’s history of under-building and low ownership
5 u- z' W5 @- k5 g9 K7 y: Prates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
! v  T3 m! q3 Jcondo market. Both in Toronto and Vancouver, historically
, I3 O$ F* E6 ~7 S: z# J+ T5 ohigh levels of apartment-style units presently under
* s: d. G, k  v4 g9 \% p' @, Wconstruction mean that record numbers of condos will
: ]9 r+ \8 L. C$ U0 creach completion during 2009. If absorption rates fall, as
) b/ j4 o0 s4 c' F1 e% k) N5 scyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
$ }6 [' k0 ^" P9 p4 M& `residential construction in B.C. will definitely droop, we
* y. x  A1 Z$ J3 Q% e; c& I# Aanticipate that the West Coast will continue to benefit from
inter-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
MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
- i- z4 o6 ]+ h2 B, M416-982-8063
* y' o, @7 R" U! t* H8 Y1 @6 vPascal Gauthier, Economist
416-944-5730
# t1 U% u  [$ d' H5 g  D  |
7 k- H# ]: z! V+ T0 c7 ^1 ahttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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