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
unsustainable levels of building. Our view is that house
6 J' ?! S, E9 r* g* Q4 P6 cprices exceeded the value of housing that was justified by
4 y- P+ E1 q4 j6 B, m; E5 sfundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
, w) z* B  M& qthat exceeded its fundamental-justified level by approximately
* W- X# g* {1 b0 o, n12%, an excess that was exaggerated in the past
three years.
By “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
both a cyclical downturn and a return of house prices
# L: r; l) U3 {# f$ a1 A) P( E$ eto fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
that 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
& c- ~/ _, `9 A0 e. S“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
8 j, g. y6 l1 ?; |) ?; nthat is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
4 d( f" D1 z7 c; xthe construction of too many new homes over the boom
# _8 h. X: Z6 o0 f# B" L' Cmeans a deepened slump. This overbuilding will likely weigh
on markets over the next few years. Even as Canada recovers
8 N, h9 x9 s2 j3 Y- X; tfrom the cyclical downturn, house price growth will
7 Q* o% J" l& P: |" eremain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
2 K' F- {9 V; d: yis now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
1 B3 q" o3 i- @; P. `& }  R$ Lresidential construction will fall further to around
: b: \% ~* X' C- i7 E125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
To quantify the degree of overpricing and overbuilding,
we first develop an empirical model, based on long-run
fundamentals of house prices and housing starts in each
( ~- A% q% @1 Z$ ]province. Affordability is the key concept behind home
values since house prices should track incomes over the
6 X- o# B5 n* `6 B. A/ b9 ulong-run. Since homebuilders build to meet demand, we
regard housing prices and household formation as the drivers
' u: z! G- V5 N& O% \. U$ g* Wof residential construction.
To examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
* E; Y& P* {* l0 a- [4 Jwould have occurred if housing had been priced
8 Z1 Z, {5 `  toptimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
# K; |$ u- k: D5 I/ Yunits were being absorbed, homebuyers simply bought too
; k+ _2 \& h" ~: Y3 |9 Jmany 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
$ ?4 B+ \7 s) T5 H! I4 m9 x# z( Aalready witnessing surges in their unsold new homes at the
very time that the resale market has swung into strong
buyers’ territory. Homebuilding in the Atlantic provinces
  Q1 I' z0 b5 X( o/ Chas been relatively balanced but, while not plagued by structural
" l' s! a  e2 ]) ^weakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
# a9 D) a( `& o6 ?9 j# |/ b' sstrange accumulation of unabsorbed multiples on l’Île de
Montréal – but recent building has been relatively balanced,
given the province’s history of under-building and low ownership
3 I; b5 n- u6 F4 J& M& `rates. While Ontario homebuilding will reel from a
+ M9 `, C" D8 V) \" Scyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
% p$ t3 E; w6 q7 o0 ]condo market. Both in Toronto and Vancouver, historically
7 Q7 S7 K4 y) X. n7 x& m* g" G7 Whigh levels of apartment-style units presently under
construction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
6 V. k) G6 y) S- A8 a* F8 Ucyclical factors would indicate, condo inventories could
spike 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
inter-provincial and international migration over the coming
years, which, along with improvements in affordability,
' ~4 D2 n  r- w  @will alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
! q' e8 w" e8 v" y: S416-982-8063
9 z! G- q# L% L4 OPascal Gauthier, Economist
416-944-5730

http://www.td.com/economics/special/gb0409_housing_exec.pdf

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