TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
  H2 H1 b" n  N; c. p& efrom 2002 to 2008, unsustainable price increases drove
/ L6 T; e9 \' Nunsustainable levels of building. Our view is that house
( ~+ P% E! U8 v7 |prices exceeded the value of housing that was justified by
# S" g# u1 D- q3 rfundamentals by approximately 9% nationwide. This
: h3 t4 f8 Q: [) yoverpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
three years.
By “overpricing” we mean that prices detached from
+ G: ^/ X+ K) V' F' itheir fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
6 \- I# e# C, G# ^6 @both a cyclical downturn and a return of house prices
to fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
  B) S. l( ~7 h9 wthat this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
6 T( N0 b8 M) dthere is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
; e8 h* o' i) j+ n) Hhomebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
! O% A) z& I5 W, ^! `; Nthe construction of too many new homes over the boom
means a deepened slump. This overbuilding will likely weigh
4 {6 l( d. Q' `( d0 Gon markets over the next few years. Even as Canada recovers
from the cyclical downturn, house price growth will
# R2 {) t" h/ x# C6 nremain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
3 ^0 p) b" C' Bis now undershooting fundamentals and we expect this
  Q7 ?4 o$ d2 F0 }! ?; q9 e6 dto persist over 2009 to 2011. We anticipate that nationwide
residential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
- l0 ^8 V/ I( H6 c" q% R7 L5 VTo quantify the degree of overpricing and overbuilding,
' C# y. b9 k4 a$ A7 v! z0 g. V( fwe 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
) C: N! u! k% n' |0 i$ N6 Rvalues since house prices should track incomes over the
long-run. Since homebuilders build to meet demand, we
regard housing prices and household formation as the drivers
: {4 Y4 y' c$ a% ]' ]3 Oof residential construction.
To examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
9 X. q/ s. W3 moptimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
5 _; c, B! o# U* h, G7 u3 Dunits were being absorbed, homebuyers simply bought too
* J" H' s0 c$ N7 d' ]+ ]1 Z1 _many houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
' g9 c9 o# k' D0 |" E- ~, B8 F: ^population inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
) W0 Q' o4 c* r0 B2 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
% x# l  @* S" Nstrange accumulation of unabsorbed multiples on l’Île de
Montréal – but recent building has been relatively balanced,
# Q! l: ~5 }: O4 `given the province’s history of under-building and low ownership
rates. While Ontario homebuilding will reel from a
5 Z; ]% {6 Q& w- ~cyclical downturn, the degree of structural weakness appears
3 d5 Z7 ~. ~+ P2 {# a0 l1 ]0 Y* klimited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
8 w5 Y/ _1 G: @4 h6 E! Gconstruction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
' I& z1 b. Z+ ospike severely – particularly in Vancouver. However, while
$ p: l  W! y2 V5 s5 b% @) \: ~- lresidential 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,
1 ?6 y; b7 Q" j- c* ?will alleviate some of the pressure from overbuilding.
: \4 s* b# V2 K1 d$ W5 OOVERPRICED AND OVERBUILT: CANADIAN HOUSING
) s+ }+ T$ u2 yMARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
+ J7 r% {& k+ }* [  {- i4 EPascal Gauthier, Economist
416-944-5730
4 C, ~  E, ?. k
; X  T8 `! Z. thttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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