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
" P+ f3 K! H4 _/ Qunsustainable levels of building. Our view is that house
; Z3 O+ D9 h3 V' W( N( J' sprices 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
- D! W) H& J0 g0 |three years.
6 P( i) X' X. y+ D- x% F5 tBy “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
- h2 J4 w! g- }& m  b1 I5 mboth a cyclical downturn and a return of house prices
to fundamentally justified levels.
. ]$ A7 u$ p7 S! g* A7 UWe consider “overbuilding” of two forms: “demanddriven”
5 C; h6 K4 \: y9 u4 }  Hwhere homebuyers buy up too many houses and
: B6 f9 W: N' D+ ^% athat this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
' G4 K! k% W' L- d# I8 {“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
+ H+ f* ^6 a% C. R, A' Ethat is now being rapidly reined in.
9 l  n; v7 L# L- TWhile most markets won’t face U.S.-style overhangs,
( m! \" |! l% e* g9 A: M* o1 @# k6 `+ ^the construction of too many new homes over the boom
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
; I& w( o3 f: L# v" j, Z; h, u9 sremain choppy and new residential construction will be
9 J' ~& h7 d5 D0 t$ G$ f3 O: xdampened, owing to this structural weakness. Construction
# O7 L3 S7 [' {+ F7 Z9 Nis now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
1 _0 [& ?& M0 ]7 X5 j) Mresidential construction will fall further to around
* E" d% }) W4 L# R! \% \# C" v125,000 starts over 2009 with a trough around 115,000 units
' r" z3 Y( Q3 c( s3 q4 F3 m# H* Xin the fourth quarter.
9 k* y! `- b5 m8 b9 E; iTo quantify the degree of overpricing and overbuilding,
' a# J) v% G* [( p) }we first develop an empirical model, based on long-run
fundamentals of house prices and housing starts in each
1 C" y$ O  ]9 c$ r& a/ M9 @. T% l' [province. Affordability is the key concept behind home
* ~6 {3 S4 {1 [+ w* j+ lvalues since house prices should track incomes over the
& C" {" P0 e- {( l- ~0 Rlong-run. Since homebuilders build to meet demand, we
& E# B1 Q4 q# Xregard housing prices and household formation as the drivers
, @# H1 G% S9 m, t6 @/ [) Aof residential construction.
# f" @5 k4 P2 W( g3 U, k. j: {To examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
% Z. u* i# Q4 X2 v$ Wwould have occurred if housing had been priced
- n3 W9 Z, c# h( H# \optimally. We find that actual homebuilding exceeded this
7 w- r( |+ N7 m9 bfundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
, y/ }& d% Q2 K. g* QRegionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
+ n' f" }0 n5 t% `9 ]# \already witnessing surges in their unsold new homes at the
* k+ K4 X: R8 n# b+ hvery time that the resale market has swung into strong
1 U6 m+ M; [& ?. B  L  V& ~! ~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
/ M6 \& K" `, C/ zMontréal – but recent building has been relatively balanced,
4 I: o- z! S& g* B# Q3 \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
0 H( D. Q# p/ P" I# \condo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
construction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
% x1 D5 K9 @! \4 pcyclical factors would indicate, condo inventories could
2 S3 S: D/ t2 z$ qspike severely – particularly in Vancouver. However, while
9 v0 _6 P6 S/ c8 Sresidential construction in B.C. will definitely droop, we
  B9 K1 I5 N% canticipate that the West Coast will continue to benefit from
inter-provincial and international migration over the coming
' {: h  `2 h9 @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
416-982-8063
" U" _8 d5 o8 Y/ ?; z& R) d/ {Pascal Gauthier, Economist
3 q# d0 n9 d8 `) @) t& N416-944-5730
7 w9 o: P8 V" b  E/ x
" Z3 w/ P3 B0 O* Lhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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