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
- D2 t4 A, ]) @$ Uprices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
* U  c: Y" u7 g: x+ T$ q$ P# \overpricing compelled a level of residential construction
$ N& z( [4 h* g' n: a6 s1 Ethat exceeded its fundamental-justified level by approximately
5 R' n7 M9 s1 Q8 E* X$ U12%, an excess that was exaggerated in the past
$ C- _) U, H. c% F6 mthree years.
% G! i# C+ ~) Z' j" {& ~' }# c8 SBy “overpricing” we mean that prices detached from
! @( l: C. P! h0 k' S* B- ~their fundamentals, as witnessed by a steep erosion of
1 m' f* S* z3 \. [affordability. The current unwinding of house prices reflects
both a cyclical downturn and a return of house prices
( K4 A/ `* C% _/ ?' p: `) ^" mto fundamentally justified levels.
& S, L  t; x( }* OWe consider “overbuilding” of two forms: “demanddriven”
: q. U. g+ \- b9 jwhere homebuyers buy up too many houses and
# ~8 T0 I" G, w  ythat 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
“overbuilding” was mainly of the first type, where
) {3 D1 F- F( y8 |homebuyers pushed homebuilding to an unsustainable pitch
' K% c2 O+ F# Wthat is now being rapidly reined in.
% j* J2 w+ F/ t0 `: @) A6 j8 s4 tWhile most markets won’t face U.S.-style overhangs,
# w- d4 R  O, Uthe construction of too many new homes over the boom
! Q: z; X( U! n" a; A0 o/ hmeans a deepened slump. This overbuilding will likely weigh
; b/ M: G& l, w6 @8 w3 `on markets over the next few years. Even as Canada recovers
" T: u% i0 a2 [* Yfrom the cyclical downturn, house price growth will
remain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
2 {0 J( J/ q1 @9 U1 S% ]" J& ^* qis now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
residential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
/ g$ D  u7 t8 Q! d( i* Jin the fourth quarter.
; V; X( \8 n$ h* q! X( qTo quantify the degree of overpricing and overbuilding,
we first develop an empirical model, based on long-run
fundamentals of house prices and housing starts in each
) J5 c% T. V  d7 O6 }province. Affordability is the key concept behind home
2 T5 h# B3 n6 c7 C+ avalues since house prices should track incomes over the
2 g# i5 N$ {! flong-run. Since homebuilders build to meet demand, we
regard housing prices and household formation as the drivers
$ i7 j- P4 B/ R  l! z* m) i- Q  f6 fof residential construction.
To examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
3 r8 v) O+ ~. U) H/ }  g/ J0 awould have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
& _! U  v# {0 N4 N, e* y& Nunits were being absorbed, homebuyers simply bought too
5 \% N- }! S; K, P- @/ Umany houses at prices that exceeded fundamentals.
  p! o! P; w& uRegionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
) D4 b' ]) k* X* P: q. c5 palready witnessing surges in their unsold new homes at the
$ _$ G9 Y0 j# ?" ~' J6 x& F! Cvery time that the resale market has swung into strong
; Y, l" L' Z+ p2 wbuyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
weakness, will be singed by the downturn nonetheless.
6 e6 E! A. Z7 jQuébec shows signs of strain – especially given the
strange accumulation of unabsorbed multiples on l’Île de
Montréal – but recent building has been relatively balanced,
! C' F0 h: p  Rgiven the province’s history of under-building and low ownership
& R/ d8 p* J7 ?9 Prates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
7 k6 s" B+ J9 e  W4 h; I) d9 Hhigh levels of apartment-style units presently under
construction mean that record numbers of condos will
  ]! ~% Q) |6 E8 L" W/ K  areach completion during 2009. If absorption rates fall, as
' v' c& e$ w$ `, M" |cyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
residential construction in B.C. will definitely droop, we
& f/ M6 P' r  f( d1 Aanticipate that the West Coast will continue to benefit from
inter-provincial and international migration over the coming
( J9 R+ d& I1 e/ d' tyears, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
* q0 Q7 w8 r. L+ e# t, y3 V3 b' LOVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
7 e4 N& W& F$ @' ~& j416-982-8063
Pascal Gauthier, Economist
4 U; g& c) i! D, p" z0 L  M416-944-5730
0 U% n% a& X; p" l
; f3 m" g0 D% j: N# H. ?http://www.td.com/economics/special/gb0409_housing_exec.pdf

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