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
+ @- I0 s+ r9 D# y. Y( lprices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
  a! |) A8 [/ D  Zoverpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
& Z: p2 K5 O( H9 gthree years.
& x, y( a8 q6 v& RBy “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
% w6 g6 Z' u8 waffordability. The current unwinding of house prices reflects
both a cyclical downturn and a return of house prices
4 d/ F3 g( F6 n: L$ ]6 v  F( d! T9 Kto fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
  q. E# B! }! M% O8 G1 P+ O, \where homebuyers buy up too many houses and
* f7 B5 Q$ ~6 ?& uthat this demand cannot be sustained; and “supply-driven”
8 S' `$ J) V, Q+ Y$ a9 twhere builders accumulate excessive inventories. Although
8 C  X) Y& c: \7 W/ tthere is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
% B# z3 ^" N5 w0 V3 fhomebuyers pushed homebuilding to an unsustainable pitch
! m; v3 l6 J) k( q1 Kthat is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
- h' }) o3 f" D/ v& I+ Hthe construction of too many new homes over the boom
  B7 H( V% g  S; s; ?$ D4 Nmeans a deepened slump. This overbuilding will likely weigh
on markets over the next few years. Even as Canada recovers
from the cyclical downturn, house price growth will
& Y; ]9 ^3 E( W0 Jremain choppy and new residential construction will be
+ z( ^( y1 `0 c! b6 Wdampened, owing to this structural weakness. Construction
4 [" Q1 G# \! s9 \is now undershooting fundamentals and we expect this
7 r. _0 W9 `/ e# ?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
in the fourth quarter.
To quantify the degree of overpricing and overbuilding,
5 M2 B! G0 Q5 I3 c. B) }' v- g) z' Ewe 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
values since house prices should track incomes over the
. r9 U" m5 ^' E* F& r7 mlong-run. Since homebuilders build to meet demand, we
/ H  c- f2 P: ?; U/ `0 i3 iregard housing prices and household formation as the drivers
of residential construction.
To examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
: P% ?/ x' C  [would have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
6 s7 Q9 w4 K5 F4 Junits were being absorbed, homebuyers simply bought too
& M6 T* q  _" @0 fmany houses at prices that exceeded fundamentals.
/ p+ g7 r6 q3 ^, C; e% B/ M/ ^Regionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
7 z6 g/ k6 P9 F9 X: }" f: Z! r/ n! s6 W! Qvery time that the resale market has swung into strong
buyers’ territory. Homebuilding in the Atlantic provinces
* A) R) t' s8 X1 G6 bhas been relatively balanced but, while not plagued by structural
5 n1 l# c1 a/ ]  `) P6 u$ _! F4 Gweakness, will be singed by the downturn nonetheless.
; D# H9 n- F0 X! A9 NQuébec shows signs of strain – especially given the
strange accumulation of unabsorbed multiples on l’Île de
# a! N8 H( ~) B/ j! x, a/ r& `Montréal – but recent building has been relatively balanced,
given 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
# s1 U7 k8 `7 J1 M, b, |limited – with the important exception of the Toronto
' g% v* r9 M" V/ G1 }- M( Mcondo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
( Y# n' N! |1 @; Aconstruction mean that record numbers of condos will
" W8 _! d; Z5 Creach completion during 2009. If absorption rates fall, as
! C: |$ k2 G4 I8 p1 _: a$ jcyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
residential construction in B.C. will definitely droop, we
+ d* h7 _8 f2 t* L! W/ _* S& yanticipate that the West Coast will continue to benefit from
inter-provincial and international migration over the coming
years, which, along with improvements in affordability,
, W/ k( H8 W: I& Kwill alleviate some of the pressure from overbuilding.
. f6 V3 x/ M3 U$ pOVERPRICED AND OVERBUILT: CANADIAN HOUSING
; t' D3 a0 E& B0 B! v) ~& \& xMARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
Pascal Gauthier, Economist
416-944-5730

6 i( G7 P. }3 u8 g# Qhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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