TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
( _  ]# d/ {' P! y% A0 T1 ?from 2002 to 2008, unsustainable price increases drove
unsustainable levels of building. Our view is that house
- a6 B& {+ j" Vprices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
6 g1 N8 m& l* R( \that exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
three years.
) r+ m! m  s( [' @- `& B5 u8 `* qBy “overpricing” we mean that prices detached from
; W" Y; {* \# I7 j4 x9 B' ntheir 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
  a) s; S, z! @. h3 p8 d) P+ _that this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
6 p7 v% p# F, o, Kthere is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
4 {& s2 W. i- l/ _7 phomebuyers pushed homebuilding to an unsustainable pitch
! Q/ P" a# H( q# F0 rthat is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
) q3 K/ J9 W3 I* s. e$ [  o+ O% s' hthe 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
from the cyclical downturn, house price growth will
8 Z0 {& W/ [  t2 z( v, J/ L2 jremain choppy and new residential construction will be
& y- z3 r* Q/ D* }1 Ldampened, owing to this structural weakness. Construction
' z. n1 Y  T8 X: Uis now undershooting fundamentals and we expect this
9 _  Z7 L. f8 X3 V. t: R3 Y4 sto persist over 2009 to 2011. We anticipate that nationwide
' p9 g3 N. F0 D' ~0 Aresidential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
/ [# u+ l& {3 z9 R+ wTo quantify the degree of overpricing and overbuilding,
1 u; e! q0 R* ], P" ~0 z& Mwe 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
7 V7 A2 D  w. N3 Dvalues 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
% P6 ^$ A( l2 n- ]of residential construction.
To examine the degree of overbuilding, we employ a
2 i6 w/ _9 R5 C' ~: w& W! d. G' h1 r“counter-factual,” asking what level of residential construction
+ O$ \) r; U- J; Q1 c& g5 {$ D% ?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
/ _, {% K: N9 S( ?7 pmany houses at prices that exceeded fundamentals.
+ O% N# M1 K: E1 zRegionally, we see the greatest strains on the Prairies,
1 Z7 u. v$ a8 awhere housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
very time that the resale market has swung into strong
buyers’ territory. Homebuilding in the Atlantic provinces
, r' X2 w: ~& Z1 H9 D2 lhas been relatively balanced but, while not plagued by structural
$ R* w& o6 W: Z4 e% J5 d# N9 @$ qweakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
& B/ }8 f+ [: a! f5 R; c9 gstrange 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
4 d& N- }8 ]! A, |7 srates. 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
high levels of apartment-style units presently under
/ q; l  i' B* o' D9 d/ oconstruction mean that record numbers of condos will
2 V) g+ l0 j5 X0 G/ o7 H( Z6 Zreach completion during 2009. If absorption rates fall, as
9 }& D0 N5 w  wcyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
( w1 k  G, S" H' R" [residential 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
" n$ \3 I' ?2 V  K2 l- tyears, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
4 n$ h7 }" Z! j2 VOVERPRICED AND OVERBUILT: CANADIAN HOUSING
: Z% K6 H) p) }; U+ b* E3 nMARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
Pascal Gauthier, Economist
2 Y  t5 b' S+ X# @, C416-944-5730

1 o2 E! V$ [/ E- L3 S- lhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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