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
+ ~1 ~' i, O# s& Y' V' I. k; vunsustainable levels of building. Our view is that house
prices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
7 {. x' ]2 _. ^" S6 E, Pthat exceeded its fundamental-justified level by approximately
! x! O# c' K) m0 j. {' O8 T8 b12%, an excess that was exaggerated in the past
three years.
8 p+ C0 T$ C4 G9 B. @/ l+ UBy “overpricing” we mean that prices detached from
4 u2 z7 l5 D1 W4 w% dtheir 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”
where homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
% b, u9 l$ f# V" othere is evidence of both types, we contend that Canada’s
9 p! E6 R. @2 X# H' a“overbuilding” was mainly of the first type, where
# v5 \1 z# d6 r0 ~) j  u1 t2 V# Khomebuyers pushed homebuilding to an unsustainable pitch
that 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
" e8 S3 q. i8 w4 fmeans a deepened slump. This overbuilding will likely weigh
: k! S# H/ Q3 H" B0 kon markets over the next few years. Even as Canada recovers
' L$ j  V+ M0 Nfrom the cyclical downturn, house price growth will
' d' {) l1 k9 ]3 d* L) ~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
( l1 y+ q* U6 q9 t8 A* a8 ?residential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
( C' `) P8 n& Lin the fourth quarter.
To quantify the degree of overpricing and overbuilding,
' @# _' I  L* ~+ [1 C0 Awe first develop an empirical model, based on long-run
) U2 \6 s1 H, f: |fundamentals of house prices and housing starts in each
8 c% U0 t% X  Z) T$ C5 f& e! Dprovince. Affordability is the key concept behind home
5 w5 v( }3 D7 A# `4 d- @# Mvalues since house prices should track incomes over the
$ C. {) G' s- T6 w, y* u2 l9 ilong-run. Since homebuilders build to meet demand, we
regard housing prices and household formation as the drivers
of residential construction.
5 g' B2 o9 |' w! x& m. g- qTo examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
would 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.
, O# R/ ~% ?' F8 v$ b! |Regionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
) v# U# W8 A0 F' c- Kpopulation inflows. Saskatoon, Calgary and Edmonton are
' z) `  E$ y! V3 J- P, {) lalready witnessing surges in their unsold new homes at the
8 L, s, q; _# M: ^" Rvery time that the resale market has swung into strong
$ K' M! q" H6 O# q6 z) dbuyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
weakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
- _9 c6 N7 k' }' \# tstrange accumulation of unabsorbed multiples on l’Île de
4 R  ]% @* S! f) UMontréal – but recent building has been relatively balanced,
given the province’s history of under-building and low ownership
2 Y/ O, |: ?- V: grates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
0 P( H) I1 b6 P% k: d4 olimited – with the important exception of the Toronto
. k( x2 a. ~/ a7 B; l8 Rcondo market. Both in Toronto and Vancouver, historically
7 q& L4 Z- F' C; j/ h! f6 Fhigh levels of apartment-style units presently under
construction mean that record numbers of condos will
% V, r7 @& t! ereach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
2 F0 F: a7 n1 Q* i4 Fspike severely – particularly in Vancouver. However, while
residential construction in B.C. will definitely droop, we
" C, x* {- y$ eanticipate that the West Coast will continue to benefit from
9 y& b1 n5 K) u7 W& h0 i" ginter-provincial and international migration over the coming
years, which, along with improvements in affordability,
1 a; f+ s1 N2 k3 M( x3 i; kwill alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
4 N7 f% [& d5 a1 v$ APascal Gauthier, Economist
416-944-5730
# p+ b, z# Y) W
( f1 Z8 {$ Y$ M0 d' Q3 Hhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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