TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
" B% P6 G4 B. @, ~) }0 Hfrom 2002 to 2008, unsustainable price increases drove
unsustainable levels of building. Our view is that house
. Z! _1 p, Q2 A2 {7 Nprices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
' W+ }' M! J- s" Y) r. Pthat exceeded its fundamental-justified level by approximately
* G, ^7 }4 V/ q7 |12%, an excess that was exaggerated in the past
three years.
By “overpricing” we mean that prices detached from
% k# X$ @$ p  j: z7 u: W+ N9 Itheir fundamentals, as witnessed by a steep erosion of
' E. t; W7 x& Qaffordability. The current unwinding of house prices reflects
9 W* f2 n6 Z8 g; x' m% \: v+ kboth a cyclical downturn and a return of house prices
to fundamentally justified levels.
" p. ?) \2 S/ RWe consider “overbuilding” of two forms: “demanddriven”
7 |+ N, ~% {- Z6 x5 ^where homebuyers buy up too many houses and
4 F$ d/ T8 n& a* P" ]that this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
6 [0 o7 H/ V4 i0 Bthere is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
- h8 @4 ]3 z6 j  G# G8 OWhile most markets won’t face U.S.-style overhangs,
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
7 e% G" y) d1 V8 C3 L: p) s, |7 e; Wfrom the cyclical downturn, house price growth will
remain choppy and new residential construction will be
; |6 u7 ~+ i% c& r' Tdampened, owing to this structural weakness. Construction
is 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
in the fourth quarter.
To quantify the degree of overpricing and overbuilding,
& T, l- A1 Q1 ]) C3 p8 f( B3 _we first develop an empirical model, based on long-run
fundamentals of house prices and housing starts in each
province. Affordability is the key concept behind home
9 a- V3 ~  A+ A) v; ovalues since house prices should track incomes over the
) m( t( `+ |6 l! _2 llong-run. Since homebuilders build to meet demand, we
/ N; m1 `, m$ _8 b) [- l$ M# Oregard housing prices and household formation as the drivers
of residential construction.
To examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
$ ^, e& z9 O- g2 c5 Q& [1 ]would have occurred if housing had been priced
" p/ L6 X: |: ~& |$ u: B4 R* b( Woptimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
% x  j/ |% |4 k6 XRegionally, we see the greatest strains on the Prairies,
3 s" z, Y+ A) H1 owhere housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
4 R7 H+ m: {# U3 {very time that the resale market has swung into strong
3 z" f' z/ Y  r* }& H5 Cbuyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
) o, k# p1 Z4 }+ n0 pweakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
strange accumulation of unabsorbed multiples on l’Île de
+ x1 D9 ~" N" k1 dMontréal – but recent building has been relatively balanced,
/ {6 r# u# t8 \' I  p) `5 P& O  y3 egiven the province’s history of under-building and low ownership
# R& n0 M$ }8 q; ^# Z+ I8 a5 ]rates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
2 \5 |+ O; L- s5 _% @- F4 o3 Llimited – with the important exception of the Toronto
condo 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
cyclical factors would indicate, condo inventories could
9 m: C/ ?& J2 R5 r, aspike severely – particularly in Vancouver. However, while
5 Q  ^; L6 ]4 hresidential construction in B.C. will definitely droop, we
" f3 C) [. h3 A; V; H5 v8 q' yanticipate that the West Coast will continue to benefit from
" G, s2 W  g& V2 F- k6 ninter-provincial and international migration over the coming
; }. k, D* M2 F* t3 R6 eyears, which, along with improvements in affordability,
( X9 O' t5 Y0 i6 x8 C' mwill alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
. I, m1 S& T3 ?. @* J! V1 }Pascal Gauthier, Economist
  X9 J3 r9 Z, e0 X# A- Q% i416-944-5730
, i! O+ u7 j  x. O9 T- g5 \- v
# M$ p4 ?: E4 i+ [- k9 Ehttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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