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
* N  |: _% g  c( zunsustainable levels of building. Our view is that house
) g. U* ]7 d3 T6 |9 x: ^prices exceeded the value of housing that was justified by
- b* m- B/ C" Cfundamentals by approximately 9% nationwide. This
; V, t4 a& ?. Y; Soverpricing compelled a level of residential construction
9 l$ f, U. c6 c3 w; a: nthat exceeded its fundamental-justified level by approximately
+ C8 }. q* w2 [0 L2 G& w" \* N7 c12%, an excess that was exaggerated in the past
% ~1 B0 l4 X2 Xthree years.
, m" P6 N% T0 s  {By “overpricing” we mean that prices detached from
3 b8 t$ A' v: |5 r. Q  Ytheir fundamentals, as witnessed by a steep erosion of
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”
, k# x/ \3 @* uwhere homebuyers buy up too many houses and
2 T7 y0 j) o, w  `  P5 ^that this demand cannot be sustained; and “supply-driven”
9 y# {. I4 B9 Jwhere builders accumulate excessive inventories. Although
8 t* \2 a) \+ |; u9 i3 m$ athere is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
/ ?, k+ s* a: _+ @& y. hhomebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
. l' g3 N( Z/ ?& Kthe 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
" @6 @/ x* |9 u: Ifrom the cyclical downturn, house price growth will
remain choppy and new residential construction will be
* m0 ]/ Z7 L, M2 r5 c' |/ Pdampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
4 N, Y7 p4 E% Bresidential construction will fall further to around
/ e/ \! v7 X. k125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
To quantify the degree of overpricing and overbuilding,
) P- J* {6 Z; C$ C  Lwe first develop an empirical model, based on long-run
+ C6 z& x# v8 i) efundamentals of house prices and housing starts in each
province. Affordability is the key concept behind home
% V: ?) A; z3 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
  ?1 p: ]5 ~; E9 Y/ |2 c3 aof residential construction.
% z0 ^- s. ~# {4 XTo examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
/ u  U4 j3 _* h" a. qwould have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
8 T6 _* s5 \1 a0 iunits were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
: p( P4 y# w1 x; V' S! i1 c; eRegionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
) w+ o' M3 ]. j1 ^population inflows. Saskatoon, Calgary and Edmonton are
: ~- B: t+ A5 galready 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
  N# R1 r, |; K# i# D: Whas been relatively balanced but, while not plagued by structural
6 a1 M7 G; m, }4 X0 u; y5 [weakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
, u$ \$ q/ f7 r& xstrange accumulation of unabsorbed multiples on l’Île de
Montréal – but recent building has been relatively balanced,
& {' Y+ e) e0 I4 v( H+ J8 N+ Ngiven the province’s history of under-building and low ownership
" h2 l1 o, m) O! D/ Wrates. While Ontario homebuilding will reel from a
3 h. C" m6 L  Z7 jcyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
- c, `# s% [" V. S" V8 S0 Zhigh levels of apartment-style units presently under
& r  ]1 o6 j! E" c3 m4 }9 jconstruction mean that record numbers of condos will
0 B& y/ e  `& D2 e, W: greach 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
. q& ]1 O+ ?5 I* vanticipate that the West Coast will continue to benefit from
inter-provincial and international migration over the coming
years, which, along with improvements in affordability,
/ G3 @/ p/ N# \4 P* s. l+ Ewill alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
8 e$ u" G. |# Y3 p4 e" `; EGrant Bishop, Economist
7 s0 Y# e4 z$ W# ~$ W2 a416-982-8063
. ^" l+ D% ?% K7 zPascal Gauthier, Economist
* X0 U, g! E6 `( c416-944-5730

8 t; ]+ U" p) q; Qhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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