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
% G+ ^3 L+ S1 e2 w: d6 P+ cunsustainable levels of building. Our view is that house
prices exceeded the value of housing that was justified by
9 C5 o. }% V' u2 w+ k6 pfundamentals by approximately 9% nationwide. This
, n1 I3 e' A) S9 Joverpricing compelled a level of residential construction
4 J" n8 q3 C+ t0 }( zthat exceeded its fundamental-justified level by approximately
( P+ N# L9 i9 ~  c12%, an excess that was exaggerated in the past
- C6 Z6 O5 Q% n: ~% P9 h0 o1 n6 Uthree years.
By “overpricing” we mean that prices detached from
- {+ Z8 M  M  q& g# V- k' ~their fundamentals, as witnessed by a steep erosion of
9 u' o# y2 F0 ^, B# Saffordability. The current unwinding of house prices reflects
% |# |; _+ ~4 }  Rboth a cyclical downturn and a return of house prices
to fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
0 E3 g; t( d) U# c; i$ H" `1 s1 `% }where homebuyers buy up too many houses and
* U' B: u5 q. N1 pthat this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
3 [! y* J! p" ~# ?- x1 B“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,
the construction of too many new homes over the boom
$ D3 Y! s2 X3 n2 qmeans 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
remain choppy and new residential construction will be
) E/ G" S5 G1 u, }' o1 O6 odampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
* v' Q! ~0 L; _: oto persist over 2009 to 2011. We anticipate that nationwide
, _; f5 P- ^; _/ f# w/ wresidential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
7 W6 _1 l: Z7 b) F# F9 Win the fourth quarter.
To quantify the degree of overpricing and overbuilding,
0 \* S3 A6 x) p( D8 rwe first develop an empirical model, based on long-run
& [" J3 _; M4 @: U& h8 \fundamentals of house prices and housing starts in each
province. Affordability is the key concept behind home
5 i8 a/ S  \, c4 p$ `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
) a+ _# v  g( m5 q% yof residential construction.
% z; C% D; c  _. f1 M! b* MTo examine the degree of overbuilding, we employ a
! n! W3 R7 [: J- c“counter-factual,” asking what level of residential construction
& J- m' V: q7 Y) A: Fwould have occurred if housing had been priced
( i: n  c4 o1 i1 y7 Y! J6 d( ]optimally. We find that actual homebuilding exceeded this
3 k/ {0 A! u) G  {& i$ T: J( P7 xfundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
' {. ]$ o3 \0 G5 T( G+ s1 k1 Pwhere housing demand will further contract under waning
+ U! M$ F; q8 _. D4 }6 I8 N- v! Ypopulation 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
7 {5 j3 D3 q# [; t2 Y3 z: \buyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
  v$ w3 Y3 l/ ]: C2 Z2 h2 n. [3 fweakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
2 F; _  s+ f: f% Mstrange accumulation of unabsorbed multiples on l’Île de
Montréal – but recent building has been relatively balanced,
: S$ {: g$ J$ o/ ~* X: fgiven the province’s history of under-building and low ownership
2 c2 |/ ]) i( F! [7 Z5 k. k# T# `rates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
* Z; H  G6 n5 Flimited – with the important exception of the Toronto
3 D5 {8 z* ~3 P1 Vcondo 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
2 {% S  O9 Q/ {$ |  `, X) ]cyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
& [) \$ u5 f  m$ Vresidential construction in B.C. will definitely droop, we
anticipate 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.
* R; r8 ~* [- d8 wOVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
# T2 _: ^: y! \; y3 G+ l* AGrant Bishop, Economist
8 v  X" U" z8 e) d/ M! D416-982-8063
9 W. N" J1 S4 F2 R) j+ jPascal Gauthier, Economist
* I$ v+ p; d4 Q416-944-5730
1 q' M4 O. s0 H" z# b3 n
" J1 C8 S8 O/ r8 uhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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