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
  i# F0 E3 W% G( H) munsustainable levels of building. Our view is that house
- L. z7 |! H3 zprices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
# [& I7 s+ E% R2 A* Ithat exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
# \1 q% G& b- ~/ h7 cthree years.
% I1 b3 D: A* M& gBy “overpricing” we mean that prices detached from
3 \8 S  s9 `6 _7 Itheir fundamentals, as witnessed by a steep erosion of
' b! J: L  d8 ^+ }affordability. The current unwinding of house prices reflects
( C  Q, u6 i3 [3 q. ]  B) }both a cyclical downturn and a return of house prices
to fundamentally justified levels.
1 l. n. `4 [4 s' r" ]9 c% c( q5 bWe consider “overbuilding” of two forms: “demanddriven”
* A% Q4 h7 @2 N: }" ^where homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
7 Z0 {0 S8 }  a# A0 _% s. zwhere builders accumulate excessive inventories. Although
there 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
( `" y! ~# o  F9 g' F+ d. V' k$ d: athat 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
means a deepened slump. This overbuilding will likely weigh
5 ]! y- D: t$ S& i4 @' Aon markets over the next few years. Even as Canada recovers
% n' y- e2 ^, ]! {+ t' C, Xfrom the cyclical downturn, house price growth will
5 x0 I0 S+ P: w* q9 N% iremain choppy and new residential construction will be
2 U& I" u# c$ X9 B5 b; sdampened, owing to this structural weakness. Construction
  @4 x5 z7 l) I% L  P- Ois now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
5 p6 G! |5 X  ^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,
" z- J9 _6 @2 ~! X% T9 x) dwe first develop an empirical model, based on long-run
' ~9 s- H8 R6 lfundamentals of house prices and housing starts in each
! P/ @# V- W9 v, \% mprovince. Affordability is the key concept behind home
) c' s1 T0 i" I4 evalues 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
" q: u: N" h% v6 F' ?of residential construction.
/ H  V9 J) n5 M" YTo examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
% ]: @5 |6 P$ x" |, F6 J# {1 `5 kwould have occurred if housing had been priced
optimally. 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.
Regionally, we see the greatest strains on the Prairies,
/ o$ v1 j8 @3 j" E7 v8 Ewhere housing demand will further contract under waning
, A' f0 q. g0 `5 ~/ `: `! X2 jpopulation inflows. Saskatoon, Calgary and Edmonton are
! F1 n( t& S) b3 G: e1 ialready witnessing surges in their unsold new homes at the
9 V4 K( ~9 {/ B9 {very time that the resale market has swung into strong
buyers’ territory. Homebuilding in the Atlantic provinces
, m. M- D9 b: r; ]4 S9 thas been relatively balanced but, while not plagued by structural
$ ^4 @( n* s6 B! J, s: w; Iweakness, will be singed by the downturn nonetheless.
/ F  s. z1 Y$ {' A- P( k! aQuébec shows signs of strain – especially given the
5 ~. D& q/ C) P5 n1 x& |- E0 w: Z! istrange 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
  i% v1 X# |9 Q- j& @- Jrates. While Ontario homebuilding will reel from a
) c% k( a% j/ q( g. \# Kcyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
" K: x" v5 s; N0 n! W9 c0 ccondo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
construction mean that record numbers of condos will
1 S: B! A+ ]  H7 Y- kreach completion during 2009. If absorption rates fall, as
3 N% X, ]: h5 S1 ocyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
6 Z! P2 [6 C, `, g* W7 d" v, d7 Bresidential construction in B.C. will definitely droop, we
" r# |$ I; Z: y4 O9 f( b5 ianticipate that the West Coast will continue to benefit from
- Y  {! P' x7 ~+ L7 b0 _inter-provincial and international migration over the coming
years, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
. c+ t6 [. `' J; u9 IMARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
1 X/ Z5 g4 M% H$ Z416-982-8063
Pascal Gauthier, Economist
$ D# w' r7 U  K% q, m416-944-5730

8 Q; @& z. d7 m8 Yhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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