TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
, s! K3 z: o( x1 [3 zfrom 2002 to 2008, unsustainable price increases drove
unsustainable levels of building. Our view is that house
" {2 L' e0 X' o9 Y# W+ p6 e% O$ Cprices exceeded the value of housing that was justified by
8 f5 q) A, v9 W9 Yfundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
% V4 g2 q1 c) r6 p& Bthat exceeded its fundamental-justified level by approximately
9 J, b' d8 h7 F0 ]1 v12%, an excess that was exaggerated in the past
three years.
By “overpricing” we mean that prices detached from
4 O; e+ o1 {' I2 w% S0 itheir 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
0 n+ ^- X) r, H; |: S# `9 lto fundamentally justified levels.
& n" l7 D% E" vWe consider “overbuilding” of two forms: “demanddriven”
* @2 B! r0 c4 \; J4 n4 S2 ]where homebuyers buy up too many houses and
: j1 a/ c& f' J, z) I% ]that this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
5 v: u1 z9 ^3 Ethere is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
* U" g8 y: h, W; d* V3 Phomebuyers pushed homebuilding to an unsustainable pitch
8 ~( l4 s4 A* I3 Z3 T: C* wthat is now being rapidly reined in.
! J( S* U" E* a/ RWhile most markets won’t face U.S.-style overhangs,
5 }, t( H. A% r9 _! h# q9 Sthe construction of too many new homes over the boom
means a deepened slump. This overbuilding will likely weigh
- c  u7 @' g( Z; A- Y8 b# Jon markets over the next few years. Even as Canada recovers
from the cyclical downturn, house price growth will
, _1 `3 H) d9 ^) `- I; b/ fremain choppy and new residential construction will be
3 B; t+ L/ k; V! Idampened, owing to this structural weakness. Construction
: m- N5 E, L3 g  l7 }, f1 P* His now undershooting fundamentals and we expect this
. u% _' ^; a! Zto persist over 2009 to 2011. We anticipate that nationwide
' l* r% Q; R/ z! |residential construction will fall further to around
! j  k6 ?' d" |125,000 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
" P8 A, h7 C* D2 g* zfundamentals of house prices and housing starts in each
province. Affordability is the key concept behind home
values 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
( S9 g3 I( B, eof residential construction.
To examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
7 b& v, `2 c+ w7 m' G. o* Kwould have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
2 X- I. s! c! }fundamental-justified level by about 12%. Although new
% g; k  k* I. W$ \units were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
  @, }2 N1 K1 J" U: x: y2 Ewhere housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
- t) L: b4 m3 Oalready 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
, Q# M  K* {0 }! N- G% ihas been relatively balanced but, while not plagued by structural
4 v  e- g# A; Y& Qweakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
strange accumulation of unabsorbed multiples on l’Île de
Montréal – but recent building has been relatively balanced,
# X2 M) S+ {9 Y* [) s. hgiven the province’s history of under-building and low ownership
3 f6 A; F% H- q' i1 o) Brates. While Ontario homebuilding will reel from a
2 ?) ~: I$ Z7 B. l1 Vcyclical downturn, the degree of structural weakness appears
  D. k/ T5 N# G, |- p! Ilimited – with the important exception of the Toronto
8 [% c! v$ z7 t5 qcondo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
" z; b& v- A- Fconstruction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
' o) v; g, d/ h4 M9 [$ \3 dresidential 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.
4 v8 K. k* ^/ M" P1 v# iOVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
Pascal Gauthier, Economist
  j+ I' {5 h0 h4 G/ ^416-944-5730

% V; Z8 A* a; z) Shttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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