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
9 k# F% x" h2 {3 A5 w) v0 d$ junsustainable levels of building. Our view is that house
8 I! g+ N1 c! m! L( [8 e  nprices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
2 y- S; f% L8 j2 Z( Ioverpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
$ N6 r. I8 R) Rthree years.
; T# A7 E# C( x) t0 m6 ^By “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
& A% i0 o. {$ X9 c8 l) Paffordability. The current unwinding of house prices reflects
both a cyclical downturn and a return of house prices
( x1 `' d: |9 b0 d* c1 |. u! Xto fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
# m" U5 x* z7 iwhere homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
: d; L( |: u& H3 F: K% j9 vthere is evidence of both types, we contend that Canada’s
0 p( K8 Q0 \4 [7 l' D: |; K“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
7 ?/ S. F: y( u" k6 ^While most markets won’t face U.S.-style overhangs,
3 T7 g+ ~' a& x. }- tthe construction of too many new homes over the boom
means a deepened slump. This overbuilding will likely weigh
* G2 o0 g1 p0 r2 |. T" x6 |' s1 Xon markets over the next few years. Even as Canada recovers
from the cyclical downturn, house price growth will
* _) c. Z' ]) v  h# Xremain choppy and new residential construction will be
6 @5 X8 l& M% F* M; P8 D- O5 Fdampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
residential construction will fall further to around
/ t* e3 P: h: g125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
: ]5 S. c; f5 C. pTo 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
- G! S  s- O0 Y  E* p7 q) Mprovince. Affordability is the key concept behind home
) J/ B$ p( P: }8 ivalues since house prices should track incomes over the
1 N' _- [" s; o3 Y5 P9 J5 Clong-run. Since homebuilders build to meet demand, we
( l" I( i5 G; ?9 L/ L! @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
. k% `% X/ i4 J6 J5 L  G3 }would have occurred if housing had been priced
  v5 k0 [" D9 [$ |4 Poptimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
) J( P- H3 w( m8 d' G6 Runits were being absorbed, homebuyers simply bought too
8 y( W) y! E2 A2 k" F: |# b6 |many houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
$ H) ^! r; @5 V* [where housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
( i3 J2 M1 j% }5 I" Lalready 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
has 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
2 \+ m0 v" a4 S  ostrange accumulation of unabsorbed multiples on l’Île de
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
8 I7 L- q  d2 f7 v" g, Icyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
% Q, r$ a* a" k- X1 Kcondo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
construction mean that record numbers of condos will
# m, _, i2 x2 a/ i/ i9 Vreach 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
. @$ g6 F) a# a8 |, u, l0 M0 i+ Lanticipate that the West Coast will continue to benefit from
inter-provincial and international migration over the coming
) u+ _( T5 @5 p( nyears, which, along with improvements in affordability,
) p6 l) T4 z' }$ l+ ]" A5 vwill alleviate some of the pressure from overbuilding.
7 n, |0 F2 g8 ?2 D; UOVERPRICED AND OVERBUILT: CANADIAN HOUSING
& b: F1 D0 v9 n$ I1 m1 RMARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
. p7 h/ W( ~( b# e; i4 W8 [% J- A416-982-8063
Pascal Gauthier, Economist
416-944-5730
( e, e  O! q3 J+ D2 N
3 K8 v. B% h0 \6 H( Ghttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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