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
unsustainable levels of building. Our view is that house
prices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
! F' j  l# o' X4 c, \1 I" I5 {/ Coverpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
  e3 ~7 k  f9 W12%, an excess that was exaggerated in the past
three years.
By “overpricing” we mean that prices detached from
) G$ H2 o  b' h2 ?their 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”
# t/ {+ G7 u& c5 E3 p! d( Xwhere homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
# W5 O# n0 v) f4 a9 Bwhere builders accumulate excessive inventories. Although
* j! k2 [" M9 W1 ~% t/ P* q1 }there is evidence of both types, we contend that Canada’s
5 `) N$ |& D/ |; y5 [) U9 h9 D+ g“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
) m/ k' ?- H3 ~$ u; z, u8 ethat is now being rapidly reined in.
3 K, H, b5 C$ N) A0 s0 b) nWhile most markets won’t face U.S.-style overhangs,
- t* \7 c$ l( a' I% ~the 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
8 I  q# v7 G' D; l* o$ `from the cyclical downturn, house price growth will
! }0 m9 J+ S# y! Q+ Y1 }# b. bremain choppy and new residential construction will be
( s% b' _  A( K. ]7 {dampened, owing to this structural weakness. Construction
2 D$ R; {% C1 d. h: w1 a- ]; D# bis now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
, M5 Q3 n: q( R! I. rresidential construction will fall further to around
, y$ F' z* G* K9 d% X125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
$ m2 q% W5 `, P* D. y8 `8 }To quantify the degree of overpricing and overbuilding,
: D) f% p4 ]# K) W, hwe first develop an empirical model, based on long-run
  X* G/ u# A" j. y6 nfundamentals of house prices and housing starts in each
3 R. X. Y2 z8 A5 Z1 B; nprovince. Affordability is the key concept behind home
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
of residential construction.
6 o8 J4 T$ u* I9 @To examine the degree of overbuilding, we employ a
0 v' K' I2 H3 X9 e8 f' }“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
/ E7 ^. O% t& K, P5 i+ n, Coptimally. We find that actual homebuilding exceeded this
# U, J7 z; i& @! i* I1 `# j3 Bfundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
/ L: ]& F9 t) J! {4 M5 A7 lmany houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
2 r' r6 y6 ~, y& Y1 u4 Rwhere housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
8 g" f2 T6 K5 a+ v) yalready 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
& u& e, x  H% W: k) i+ Khas been relatively balanced but, while not plagued by structural
6 z- K8 K# e3 u$ Vweakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
) A( G2 ^% ]& E8 }  Y7 V- F% }strange 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
- x7 v0 `4 L* j& w( Crates. While Ontario homebuilding will reel from a
: }6 d/ G$ m8 o! N5 gcyclical downturn, the degree of structural weakness appears
* b% V! s5 b7 C* x9 n( {/ x, {% F4 d6 xlimited – with the important exception of the Toronto
( o& L6 v* [& \' {3 v& Rcondo market. Both in Toronto and Vancouver, historically
8 G! I( g) u) l1 H* ~high levels of apartment-style units presently under
construction mean that record numbers of condos will
& G; {2 G1 O2 e: t6 |3 Creach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
0 w% f$ L# x. l' k. q, R( s' iresidential construction in B.C. will definitely droop, we
anticipate that the West Coast will continue to benefit from
6 L& r* g8 `- D1 O* X* g# Minter-provincial and international migration over the coming
years, which, along with improvements in affordability,
) e( m7 f( r9 t  }: B5 B) p5 Zwill alleviate some of the pressure from overbuilding.
7 O( d# O* p1 nOVERPRICED AND OVERBUILT: CANADIAN HOUSING
9 y1 ~$ u4 X& G4 e% sMARKET RETURNS TO FUNDAMENTALS
0 A7 A' X/ N" E: DGrant Bishop, Economist
416-982-8063
Pascal Gauthier, Economist
. ~& h" D( W# i9 g4 N$ N$ x416-944-5730
* K$ K! S& @; r1 Q2 J
0 M7 \" y  I! c, F7 yhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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