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
0 z5 B/ x6 V+ S- F2 _* Dprices exceeded the value of housing that was justified by
  M1 a+ p# b7 e; R" \+ gfundamentals by approximately 9% nationwide. This
5 Z6 m3 P+ r% ~5 d+ O1 U) Z" zoverpricing 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.
4 o3 b/ ^- `- B; K. y, b; jBy “overpricing” we mean that prices detached from
6 {5 a) r  j6 A5 J' A# Y1 l. etheir fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
4 |4 G+ h4 Q3 V, E5 L: W' ?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
% X" N% O8 h& p& F6 B' E$ U, |that this demand cannot be sustained; and “supply-driven”
3 m; h, ?1 |6 [! E- r  R8 f. Pwhere builders accumulate excessive inventories. Although
" s# j( J$ m3 ~$ Q) y- a$ nthere 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
. f% D- k( B7 U2 C" _that is now being rapidly reined in.
4 ~9 S# K) y9 G7 ]) nWhile most markets won’t face U.S.-style overhangs,
" b. _9 `; z9 n- q0 W  y, \the construction of too many new homes over the boom
means a deepened slump. This overbuilding will likely weigh
on markets over the next few years. Even as Canada recovers
- d& X% H" ^3 ~, [from the cyclical downturn, house price growth will
- w. E9 f% g5 [/ Z' P6 [remain choppy and new residential construction will be
+ E  J6 a2 d/ j0 }5 H7 G  fdampened, owing to this structural weakness. Construction
& f( x, L0 e. p. gis 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
0 u4 _: C! h! N. @% R& z* U1 ?in the fourth quarter.
To quantify the degree of overpricing and overbuilding,
. n* @( b8 L2 B% E( H+ hwe first develop an empirical model, based on long-run
  x1 T( Y5 [) G. r' ofundamentals of house prices and housing starts in each
# O1 B  N) }3 Y% R* b+ ~2 J  zprovince. Affordability is the key concept behind home
5 ~: B& N+ A# v( G3 zvalues since house prices should track incomes over the
" D+ L! H/ s0 g7 Dlong-run. Since homebuilders build to meet demand, we
regard 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
would have occurred if housing had been priced
" t/ f% ]/ D/ h0 Roptimally. We find that actual homebuilding exceeded this
+ j4 Q# T: f% `# Cfundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
* j2 i7 X# w" BRegionally, we see the greatest strains on the Prairies,
9 S- O& J5 ?: P2 f1 f) M( t6 C- gwhere housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
already 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
3 b. I  ]% T9 l1 Ahas 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
$ f  \  U+ r6 cstrange accumulation of unabsorbed multiples on l’Île de
Montréal – but recent building has been relatively balanced,
1 r% n' d( U5 }& r9 U1 z3 Mgiven 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
; r! T' M- e* S% c; Q; s) A6 ?condo market. Both in Toronto and Vancouver, historically
3 t3 N: v/ N/ Mhigh levels of apartment-style units presently under
1 z$ `1 ^& s6 A" ]3 ]construction 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
residential construction in B.C. will definitely droop, we
7 }9 Z, r6 a; manticipate 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
. e- z+ _3 l7 N, }7 l" Z8 @% oMARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
Pascal Gauthier, Economist
416-944-5730
5 O( L( X" z! }! L; ]
# F9 _; C( U' c- s3 Lhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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