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
- A( H+ P$ t* k4 i7 h1 A  Kunsustainable levels of building. Our view is that house
$ m9 O9 w: c& e2 {, A3 [prices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
* K9 Z/ M0 P+ o0 S* u8 ]3 toverpricing 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.
7 z. e0 }. U( B( X, mBy “overpricing” we mean that prices detached from
9 h9 X- a8 p0 h+ {4 s$ K5 X' L4 Atheir fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
. n' C. n; Z( g. Z* A6 T! S7 |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
that this demand cannot be sustained; and “supply-driven”
2 |& ?* O* R& o1 Lwhere builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
) y' ]: `, i" g“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
4 t  o% e" e- y( s  a7 M# p/ Zthe 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
from the cyclical downturn, house price growth will
$ }; P- _" W- \8 }, [remain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
3 ?8 \6 V$ ^2 `1 vis now undershooting fundamentals and we expect this
+ x8 P5 w" \* i8 \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,
we first develop an empirical model, based on long-run
fundamentals of house prices and housing starts in each
$ U: w  g+ q, ^) Y: N% t# fprovince. 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
- H# u5 I/ u* R' M5 l3 s0 gof residential construction.
To examine the degree of overbuilding, we employ a
$ g2 N4 x& ]/ h4 \' L“counter-factual,” asking what level of residential construction
1 s1 B7 J) Y: O; K# {1 o8 J7 `would 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.
( Y- M5 J* c+ t9 z6 HRegionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
! p( q5 D& ?  ~  u3 w& @population inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
5 K" j9 S$ R7 ^! Z4 [very time that the resale market has swung into strong
buyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
; W7 ?, \' i! ~) s2 Z0 m9 vweakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
strange accumulation of unabsorbed multiples on l’Île de
4 J7 ~& O  l* a; K- UMontréal – but recent building has been relatively balanced,
7 X8 D. Y4 R3 G# \# g/ ^, tgiven 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
condo market. Both in Toronto and Vancouver, historically
6 [7 C9 h2 B2 w2 fhigh levels of apartment-style units presently under
construction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
# l" Y" u' H, s9 A. espike severely – particularly in Vancouver. However, while
residential construction in B.C. will definitely droop, we
anticipate that the West Coast will continue to benefit from
/ y6 _! u- Y6 U4 R) b, U- dinter-provincial and international migration over the coming
years, which, along with improvements in affordability,
3 Q0 _# m5 \! c1 E9 v* ~will alleviate some of the pressure from overbuilding.
" @! T1 I0 j! sOVERPRICED AND OVERBUILT: CANADIAN HOUSING
. R& d: G1 L7 _; ?# W5 E- h6 }  mMARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
% e, U* k2 |- H* x6 Y9 q4 C% L; P416-982-8063
Pascal Gauthier, Economist
416-944-5730

http://www.td.com/economics/special/gb0409_housing_exec.pdf

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