TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
: M! B1 C; t) I% v2 ?7 e* lfrom 2002 to 2008, unsustainable price increases drove
8 s  l% u" [, `' W/ |unsustainable levels of building. Our view is that house
1 G  O- i2 m1 yprices exceeded the value of housing that was justified by
/ \' Z5 g! M! l$ _9 a) zfundamentals by approximately 9% nationwide. This
9 ?( `1 B1 l, h- [) [$ X' woverpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
1 \6 d: b2 O  s) _/ |12%, an excess that was exaggerated in the past
three years.
) J8 y) e; b1 U4 zBy “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
; o5 a/ u  @9 Y. a7 ]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
. ~0 f9 Z( G1 G/ |4 e& S; F' Athat this demand cannot be sustained; and “supply-driven”
& x& o1 _* p6 Awhere builders accumulate excessive inventories. Although
there 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
9 ~. U9 ?$ ?7 }, D; {that is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
the construction of too many new homes over the boom
. H, U  L# j' r  n, Bmeans 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
  J2 r, o" b. O0 X* R) Dremain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
1 n( P5 Y4 g4 i' W1 x3 Iis now undershooting fundamentals and we expect this
. w+ `$ c, {, |: ?' E1 S  |- u$ G' jto persist over 2009 to 2011. We anticipate that nationwide
( q8 ^- T1 C# \  {& Qresidential construction will fall further to around
& v( H: W0 l9 k/ U125,000 starts over 2009 with a trough around 115,000 units
/ a2 {2 @" q* k8 |7 |in the fourth quarter.
To quantify the degree of overpricing and overbuilding,
( z8 S6 u. K& ]4 ywe 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
& q0 y* \, |7 t9 Ivalues since house prices should track incomes over the
+ M4 W8 f2 t' c5 N# u- along-run. Since homebuilders build to meet demand, we
# K5 v/ Y) v9 j, Fregard housing prices and household formation as the drivers
) M; r/ s" m- w+ y. O5 Dof 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
6 v, b2 x2 o- t" M& ~, }3 ]- yoptimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
- Y0 K# V5 |9 s+ [many houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
$ t/ g- x+ _7 W  }6 n" f5 v8 kpopulation inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
9 {) E' ^( |' w% q& e& b+ Qvery time that the resale market has swung into strong
) g8 n) m2 E7 n( u$ V% X5 i5 ibuyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
0 J0 A9 _; m3 u6 r1 A! c& U) B' nweakness, will be singed by the downturn nonetheless.
3 a$ c0 E# S) l2 tQuébec shows signs of strain – especially given the
7 E7 a, g, e, S3 R& j) U5 Kstrange accumulation of unabsorbed multiples on l’Île de
# R  c. a5 y; v: n( l" @0 L1 H7 oMontréal – but recent building has been relatively balanced,
given the province’s history of under-building and low ownership
0 X3 ^$ l8 I& k8 I/ q8 V& yrates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
0 q' {8 g; B$ [, vcondo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
8 o, x. u( T6 {7 Econstruction 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
8 D8 U& ^) r& B! eanticipate that the West Coast will continue to benefit from
  P. F- N$ S3 U% J2 l5 yinter-provincial and international migration over the coming
years, which, along with improvements in affordability,
5 M1 x" X& W* M, b% u! `6 kwill alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
' {  m2 a$ K8 Z4 |! @' b" G9 C. rGrant Bishop, Economist
) ]- s! V' R4 H, S0 b5 u416-982-8063
& B* [4 U9 k2 ~/ H& z9 P8 lPascal Gauthier, Economist
416-944-5730

' f4 n% W. t3 q3 t0 Phttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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