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
! x& B1 C- h8 h* K7 q, Wunsustainable levels of building. Our view is that house
/ h- a- H: q" S) P! w- P4 dprices exceeded the value of housing that was justified by
9 }2 {( J/ n. _& E' gfundamentals 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
three years.
5 ~. ]2 Y5 e1 m+ D, v  s0 H4 ?By “overpricing” we mean that prices detached from
7 h0 I8 I) O  _0 j' ?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
to fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
. r; a2 A) c. C. \that this demand cannot be sustained; and “supply-driven”
5 ]  g3 b/ w% P: s- Rwhere builders accumulate excessive inventories. Although
6 z& g% d# e0 S3 O* m4 k8 Athere is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
, B, L* n5 W  {+ Hthat is now being rapidly reined in.
: Z& K6 a; x$ b" m1 p! [While most markets won’t face U.S.-style overhangs,
the construction of too many new homes over the boom
: }$ p: D% _7 K+ l. Imeans a deepened slump. This overbuilding will likely weigh
' A/ P9 U& Y( n& E  h- eon markets over the next few years. Even as Canada recovers
) ?8 r2 h- b/ \3 [* E7 d/ xfrom the cyclical downturn, house price growth will
% E* Y+ S- x$ O& bremain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
4 v9 f" d' F; lis now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
( \% [& c( [/ Z% I4 `3 t& z9 U+ q0 ^) Vresidential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
# K) x' u7 f) B8 ]' n+ OTo quantify the degree of overpricing and overbuilding,
; g% r0 e/ b& j* cwe first develop an empirical model, based on long-run
% C9 A" N7 }  C; _0 \fundamentals of house prices and housing starts in each
province. Affordability is the key concept behind home
" d, Q4 K- p' t1 }/ t+ w& Pvalues since house prices should track incomes over the
/ x0 O6 b7 A1 P: rlong-run. Since homebuilders build to meet demand, we
. ~7 J  U& ?0 Pregard housing prices and household formation as the drivers
of residential construction.
' o# [9 z' Y) A' z& oTo examine the degree of overbuilding, we employ a
  A- o+ Z- j: S5 r“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
' R' v' @& Q% _; ]units were being absorbed, homebuyers simply bought too
% M0 V8 H& E, wmany houses at prices that exceeded fundamentals.
' k7 A8 u- ~' vRegionally, we see the greatest strains on the Prairies,
. ~+ Z; o# Q: U( K2 T4 s& W" C9 ]where housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
& w- g3 B3 k5 z( c% D/ B" Dalready witnessing surges in their unsold new homes at the
% A; I- |/ I( N9 C8 _5 tvery time that the resale market has swung into strong
& v. @. K5 ^  }- {$ e" [buyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
& d* }6 G2 T" Z/ tweakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
strange accumulation of unabsorbed multiples on l’Île de
* V! D9 p+ s; u' gMontréal – but recent building has been relatively balanced,
given the province’s history of under-building and low ownership
% a  |. v5 M+ Y+ d5 C; s( {rates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
, |- s' k/ a4 E9 p) t; Z; T8 [% Ccondo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
/ T0 P. z2 Y7 f3 ~, c# H  W" bconstruction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
4 Q( _; A9 [& I2 q1 ycyclical factors would indicate, condo inventories could
0 `0 g3 A. _# Q' e( g) Z) k6 \spike severely – particularly in Vancouver. However, while
2 F; s, d% S; P7 i6 O$ k! ~4 Zresidential construction in B.C. will definitely droop, we
0 K! A8 M0 ~' ]: tanticipate that the West Coast will continue to benefit from
$ m" ~1 q& D" jinter-provincial and international migration over the coming
years, which, along with improvements in affordability,
+ A/ t3 Y% ^) r# M6 F) [0 \( Awill alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
' S. Q2 \9 ]/ ?; q4 uMARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
Pascal Gauthier, Economist
416-944-5730

! P1 r0 _# \0 t3 _5 ?# M" l$ _/ Ihttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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