TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
/ \5 ?$ ]8 U* ]; s+ J5 rfrom 2002 to 2008, unsustainable price increases drove
unsustainable levels of building. Our view is that house
4 ]8 n/ i& \+ A0 e6 y% `prices exceeded the value of housing that was justified by
. s2 k+ w6 h  q2 D3 s; lfundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
, V6 @. k9 c" v* E4 G- Xthat exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
three years.
By “overpricing” we mean that prices detached from
" V+ A3 h7 b0 l2 n4 k# F2 mtheir fundamentals, as witnessed by a steep erosion of
5 f9 q; V- T/ Y& {( F# d; jaffordability. The current unwinding of house prices reflects
both a cyclical downturn and a return of house prices
to fundamentally justified levels.
5 \  [- ?; q1 iWe consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
, _1 G0 C! I; m- V) }% Uthat this demand cannot be sustained; and “supply-driven”
' Q' Y! a# }! z9 H9 }' v( ?where builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
0 ^3 t* q# R3 \6 {“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
+ p8 u% t" X$ J0 dthat is now being rapidly reined in.
6 k) F2 P. C# Y7 o/ r: BWhile most markets won’t face U.S.-style overhangs,
$ \. [5 u" W0 i& M8 B6 R& Vthe construction of too many new homes over the boom
# L% I! Z% ^0 G5 O9 ]6 bmeans a deepened slump. This overbuilding will likely weigh
( V1 v) D( t2 L& q1 Yon 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
dampened, 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
" v; t$ T  U6 o/ a4 o3 K$ J, I1 a6 Kin the fourth quarter.
To quantify the degree of overpricing and overbuilding,
0 l& U* y  p1 g, M, o0 d9 t: Cwe first develop an empirical model, based on long-run
: F- o* [, z2 a7 Vfundamentals of house prices and housing starts in each
1 a; g* [9 Q3 w; Y0 N! I# ]province. Affordability is the key concept behind home
values since house prices should track incomes over the
5 K2 G0 u; w3 e9 m$ u" M& Xlong-run. Since homebuilders build to meet demand, we
5 w$ N& r2 q1 {3 q  wregard housing prices and household formation as the drivers
2 }% N: k+ s5 ?. Fof residential construction.
To examine the degree of overbuilding, we employ a
8 Y3 n" `9 }, J8 j& K“counter-factual,” asking what level of residential construction
' \" |1 ]4 {4 N* o; Zwould have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
) T8 `- p) I, l9 @+ r2 k  Aunits were being absorbed, homebuyers simply bought too
! `' p$ j4 P2 R. g) j) Vmany houses at prices that exceeded fundamentals.
; Y' b- f: ^) b6 z+ a9 WRegionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
$ \% f3 W* v: i& `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
# L" ]& M: `7 xweakness, will be singed by the downturn nonetheless.
% |) ]- t: n2 L( u" ]4 HQuébec shows signs of strain – especially given the
strange accumulation of unabsorbed multiples on l’Île de
0 n7 \$ |3 d6 ?" H4 m* JMontréal – but recent building has been relatively balanced,
given the province’s history of under-building and low ownership
rates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
: R% f( e* @* K- Slimited – with the important exception of the Toronto
2 {, J+ h1 R/ T. n" `; Bcondo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
. [7 b. u% _6 v. W8 l  S, O3 t' u+ Uconstruction mean that record numbers of condos will
& i$ b, O; n# ^, M- `! v+ W* l+ ireach completion during 2009. If absorption rates fall, as
1 ]1 `: b( `6 [& y" N. E# e: U( Lcyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
. M/ P3 s4 o3 T, b( `& E/ {5 Rresidential construction in B.C. will definitely droop, we
anticipate that the West Coast will continue to benefit from
inter-provincial and international migration over the coming
* ]3 B/ C( u; K# x, e4 [0 Oyears, which, along with improvements in affordability,
# ]; a3 O/ f1 u! n" Z' Rwill alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
" @* _4 s# t: K, F( F! j- B0 AGrant Bishop, Economist
3 P+ |8 n: [- d# w6 y: G2 J7 p6 k416-982-8063
( a# O; J# a8 }) KPascal Gauthier, Economist
/ b6 {! F9 Y! x" O& L: M416-944-5730

, s- u4 s8 X3 L% mhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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