TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
. B# H) ?# T, n! F: ifrom 2002 to 2008, unsustainable price increases drove
unsustainable levels of building. Our view is that house
prices exceeded the value of housing that was justified by
& f/ L- P- \8 Y) N1 Mfundamentals by approximately 9% nationwide. This
overpricing 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.
By “overpricing” we mean that prices detached from
2 \6 r  F' P) r+ u' C, r. s1 Htheir fundamentals, as witnessed by a steep erosion of
0 v; f) G4 S; P, `2 q/ Qaffordability. The current unwinding of house prices reflects
% a9 {) Z, a' j; Oboth 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”
where builders accumulate excessive inventories. Although
3 u4 n" g* X" t) c! m2 r& _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
( r% g8 Z' J8 ~6 m! H: ?' ethat is now being rapidly reined in.
: K+ ]( u5 D5 q# h# f; o7 BWhile most markets won’t face U.S.-style overhangs,
4 n' s* Z1 S1 zthe construction of too many new homes over the boom
/ u8 D3 ]) x4 {: ~means a deepened slump. This overbuilding will likely weigh
: m, Z( i" f  t) W) h2 u9 q4 b% Fon markets over the next few years. Even as Canada recovers
from the cyclical downturn, house price growth will
remain choppy and new residential construction will be
; m9 g: i/ j+ Y, G, q+ rdampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
; H: ]8 |6 Y) Wto persist over 2009 to 2011. We anticipate that nationwide
( y) H* e! l# |% v9 fresidential construction will fall further to around
" R# |7 }! y# @+ V125,000 starts over 2009 with a trough around 115,000 units
4 q% d! U. ~9 P* G2 O1 ein the fourth quarter.
8 ~8 f- j9 p$ [. }3 HTo quantify the degree of overpricing and overbuilding,
3 n- W5 a- B1 f7 Z3 a- w5 ^1 swe first develop an empirical model, based on long-run
5 @: h" {( q* L& v  W* s1 Afundamentals of house prices and housing starts in each
& k' [; }3 q' I% V' y2 q9 pprovince. Affordability is the key concept behind home
( {3 ^4 q  h: i% ?) Uvalues 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
of residential construction.
& [0 z$ b! G& Y9 d- M3 wTo examine the degree of overbuilding, we employ a
- j$ Y% X" N" r; L! p' Z“counter-factual,” asking what level of residential construction
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
9 S* u- @# l# @# P  k+ Y% g5 hmany houses at prices that exceeded fundamentals.
6 E! n$ ?1 Q1 i) y5 \Regionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
4 ?% e, a+ e: g' T# U9 F) Q( j. i8 {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
* ?! W2 o& y. hbuyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
weakness, will be singed by the downturn nonetheless.
% h  }0 X! M9 K$ `Québec shows signs of strain – especially given the
% d5 L4 M9 q& ~1 I/ Fstrange 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
cyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
" o, M) l" N4 scondo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
construction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
% J) O6 q1 x! T; |$ w7 m% J4 M4 \cyclical factors would indicate, condo inventories could
0 v% V6 F6 C- ~9 u6 _- D4 F( ^spike severely – particularly in Vancouver. However, while
residential construction in B.C. will definitely droop, we
# _3 c' ^, j' O. Aanticipate that the West Coast will continue to benefit from
  O+ i7 o- s- G9 g9 ]+ \inter-provincial and international migration over the coming
& c2 o: v% ~, z, N% o6 s6 Z" \+ z" Syears, which, along with improvements in affordability,
( y) P$ {; J7 q4 \1 X, w; z' Dwill alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
5 e. H' g. m7 ^& \MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
7 T) U/ M  ^! e416-982-8063
Pascal Gauthier, Economist
416-944-5730

: {' @1 M; k  e1 x" z5 vhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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