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
- ]# G, {5 j. ?( |3 ~2 }prices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
8 U$ u3 r5 ~6 {, h) X& d3 k3 uoverpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
1 A! Y2 w$ a1 |3 W: t# D* ^4 u% I12%, an excess that was exaggerated in the past
- e# o8 f$ T) g9 s, y. othree years.
By “overpricing” we mean that prices detached from
2 |" M' l; O2 S" dtheir fundamentals, as witnessed by a steep erosion of
. P, F* E2 @0 f" ^( R. qaffordability. The current unwinding of house prices reflects
both a cyclical downturn and a return of house prices
to fundamentally justified levels.
: ~' Q: x3 `( t- hWe consider “overbuilding” of two forms: “demanddriven”
, J! \/ g* a, l8 l3 A$ W7 W" Lwhere homebuyers buy up too many houses and
2 q/ t# k: k, C; Y4 O1 z( athat this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
: {, ^/ i6 D7 B* Y$ Vthere is evidence of both types, we contend that Canada’s
( x7 ?. G% V4 s! F“overbuilding” was mainly of the first type, where
" t1 N9 i# U5 n. H, M9 a+ J2 p+ U. K7 Rhomebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
5 n6 R+ u, B9 A" p5 S- _( Bthe construction of too many new homes over the boom
means a deepened slump. This overbuilding will likely weigh
% x! I+ y: e' _7 Gon markets over the next few years. Even as Canada recovers
  G' M& v9 q. s' d4 s) efrom the cyclical downturn, house price growth will
remain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
to 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
9 A- U5 z3 x5 f9 T; ?4 v3 f  Pin the fourth quarter.
* ?2 @; y( X4 s1 Z, tTo quantify the degree of overpricing and overbuilding,
we first develop an empirical model, based on long-run
& u( O8 ~: \1 \fundamentals of house prices and housing starts in each
1 u& K8 M" ]+ I6 uprovince. Affordability is the key concept behind home
; c% R0 H0 K3 P" s6 n- gvalues since house prices should track incomes over the
2 h2 {" i& U; u0 r3 {long-run. Since homebuilders build to meet demand, we
regard housing prices and household formation as the drivers
% Q% x# Z, y/ E2 A3 dof residential construction.
3 e# n+ {2 U9 Y9 F3 rTo examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
1 O  A, f; r- |9 l9 q9 Mwould have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
( Y5 x+ z, d3 BRegionally, we see the greatest strains on the Prairies,
+ G% _9 |7 _! B1 b; [where housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
. J6 B8 c* w) Y* P& y9 Q7 a+ ]5 Walready witnessing surges in their unsold new homes at the
- }( U. M+ L& ^% c& Z8 _  pvery time that the resale market has swung into strong
" g/ X7 u% a- A. O+ Fbuyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
9 }6 e+ G3 G% F$ H& M7 Aweakness, will be singed by the downturn nonetheless.
: w* |0 T5 L2 K* }! w& n% V8 V. pQuébec shows signs of strain – especially given the
strange accumulation of unabsorbed multiples on l’Île de
) s# |7 ]+ N. D, H; x; h  rMontréal – but recent building has been relatively balanced,
- |% p  o- z" Qgiven 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
# t# d3 ?: [# C; J; S  lcondo market. Both in Toronto and Vancouver, historically
! q% N3 p) d$ V: M3 chigh levels of apartment-style units presently under
construction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
1 K" d9 B1 q0 C0 u3 z+ bcyclical factors would indicate, condo inventories could
9 L3 \8 T. b1 ^9 h7 gspike severely – particularly in Vancouver. However, while
# z' t' x% W6 W; e& Kresidential 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,
will alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
; y+ @! t+ H3 J+ a; r* E. H+ c$ O# iGrant Bishop, Economist
416-982-8063
; }$ ]  x  E/ |4 _. f  sPascal Gauthier, Economist
416-944-5730
) H. W/ J3 b1 g1 y7 z9 l- w9 o/ _/ u
& B4 j' a& N/ q9 I) chttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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