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 M8 R9 Y' |3 L5 K+ p- C: M) t* {, aunsustainable levels of building. Our view is that house
prices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
3 z1 |% i" w% \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.
+ {- x# H/ b: V! p  DBy “overpricing” we mean that prices detached from
5 e+ Y" e1 {, f$ otheir 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”
where homebuyers buy up too many houses and
& W0 G4 F$ @7 ^3 E, B+ l. Nthat this demand cannot be sustained; and “supply-driven”
7 g$ a* o6 c: F& N7 Cwhere builders accumulate excessive inventories. Although
, t* O4 k9 r7 _, P* D% R% athere is evidence of both types, we contend that Canada’s
, ?8 B6 b6 j1 [“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
' Y) X9 |+ Y* d, I3 Pthat 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
8 R' r( Q$ r- R% M& E" Qmeans a deepened slump. This overbuilding will likely weigh
% y+ d% @0 U" s$ A0 e! lon 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
, o* ~0 U" R) v9 Odampened, owing to this structural weakness. Construction
. R& r" y2 d- G+ r5 cis now undershooting fundamentals and we expect this
/ H* ^# l4 d2 R& V2 ?+ f& c* zto persist over 2009 to 2011. We anticipate that nationwide
residential construction will fall further to around
2 A; L" b" k6 ~* b; y125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
+ C8 q/ G: R1 i* h3 S' o" iTo quantify the degree of overpricing and overbuilding,
1 g# @0 G* n& x3 [we first develop an empirical model, based on long-run
6 N, K+ n3 N) ~9 H3 W& ]fundamentals of house prices and housing starts in each
province. Affordability is the key concept behind home
( J# }4 t: S$ d; ^& Fvalues since house prices should track incomes over the
: \, \/ d6 R+ x8 S3 d2 c/ k% P5 Elong-run. Since homebuilders build to meet demand, we
regard housing prices and household formation as the drivers
& E8 q' ?$ h4 iof residential construction.
To examine the degree of overbuilding, we employ a
5 L/ p1 x4 n+ q7 |  ?5 Q“counter-factual,” asking what level of residential construction
# L0 z& F- ]! X0 J% |/ ]would have occurred if housing had been priced
/ t) R2 `% _3 v7 \$ N/ ]% P) Loptimally. We find that actual homebuilding exceeded this
' b) N( k! c3 @3 y- S8 qfundamental-justified level by about 12%. Although new
) F- @9 a+ y$ Y$ F8 c- `units were being absorbed, homebuyers simply bought too
" Y5 r  q  X5 }$ x7 o3 Pmany houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
, O" M9 J7 M1 E9 m# F0 S( b& Dwhere housing demand will further contract under waning
6 g7 A7 K  J: _! p& kpopulation 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
buyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
! W- r0 G$ D  a7 S% U' L) o8 z' \5 bweakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
. ]: ^' {, J  R! vstrange accumulation of unabsorbed multiples on l’Île de
) k9 x: d1 y- \* t* pMontréal – but recent building has been relatively balanced,
given the province’s history of under-building and low ownership
' w9 R' v3 |+ }1 B$ erates. While Ontario homebuilding will reel from a
0 d- `+ _" X- T+ T2 t; N" g$ g( T" Rcyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
2 Z) q( [: _4 j+ _. u! Dcondo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
construction mean that record numbers of condos will
* @7 j4 y1 U' E5 Y0 ~6 C: Zreach completion during 2009. If absorption rates fall, as
+ r5 ^; A3 J8 K! N8 ?0 A% h. e. ncyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
residential construction in B.C. will definitely droop, we
% w- w; ?' @5 S$ q! E1 Eanticipate that the West Coast will continue to benefit from
inter-provincial and international migration over the coming
8 h, T' U, i& j  iyears, which, along with improvements in affordability,
, V4 i% b) n) C) fwill alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
' J( B! c1 C  q9 ^( o4 {& H# e416-982-8063
* V" E* W) c5 f) UPascal Gauthier, Economist
416-944-5730
1 v0 M' F7 |  g; ?) L$ ~' j
1 I. Y5 m3 e- ]: G4 r% m5 @, H1 Fhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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