TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
- Z8 Z$ L  m+ _/ {, rfrom 2002 to 2008, unsustainable price increases drove
/ g( }1 f1 W& |. V" \0 M, W' \unsustainable levels of building. Our view is that house
# t) a" q) p4 i; x) e% |& ~prices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
% Q* e; U  F+ T/ E# I/ `4 w+ b9 Mthat exceeded its fundamental-justified level by approximately
# K8 c1 A! F9 L0 j/ [5 V" a7 \12%, an excess that was exaggerated in the past
three years.
" E6 W* ]+ l, ?4 s- d) G& PBy “overpricing” we mean that prices detached from
  Y: g5 M' S7 T  g7 X9 K4 j+ xtheir fundamentals, as witnessed by a steep erosion of
' p& t2 ^; \* Laffordability. The current unwinding of house prices reflects
both a cyclical downturn and a return of house prices
to fundamentally justified levels.
; _( f2 w) o* \We consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
- _9 e, _; [8 m+ j" p. x2 uthat this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
& e' R8 r3 w' x: z# \there is evidence of both types, we contend that Canada’s
" T; C0 D1 v5 G4 D) U/ f“overbuilding” was mainly of the first type, where
* e( s4 d/ O& V2 ]0 i4 C4 lhomebuyers pushed homebuilding to an unsustainable pitch
% ^4 f' k! }" ^: U8 W' [5 B4 R- Jthat is now being rapidly reined in.
6 i) K. o9 U2 F& IWhile 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
8 e3 @: K3 `! @8 won markets over the next few years. Even as Canada recovers
% k  `8 K% E9 f& c( hfrom the cyclical downturn, house price growth will
remain choppy and new residential construction will be
7 F9 D4 F' S, i( @% `" ]. g" Sdampened, owing to this structural weakness. Construction
6 a0 k& ]% s' u  Uis 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,
* s  w, |$ C; K" [0 jwe first develop an empirical model, based on long-run
fundamentals of house prices and housing starts in each
9 N  r$ S7 Z  r+ b$ \, vprovince. Affordability is the key concept behind home
- V, R" M7 h  Q9 m# F  j6 bvalues since house prices should track incomes over the
) m9 X, H! U, }* klong-run. Since homebuilders build to meet demand, we
/ c/ i0 v# |- a: b+ G7 Mregard housing prices and household formation as the drivers
8 a* ]: x( H) F, ^- ?of residential construction.
& S/ L5 C5 x8 u8 h) oTo examine the degree of overbuilding, we employ a
" h1 ]5 B" x( ~7 z/ d“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
" a4 Z+ e* U4 y* M$ g0 J7 @optimally. We find that actual homebuilding exceeded this
0 `3 k% s: i8 A8 jfundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
7 v1 B( ?" Z1 Rmany houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
) _- o0 q1 a: T( R3 h$ @0 Apopulation inflows. Saskatoon, Calgary and Edmonton are
2 o; V! X- O. @6 m4 H' Z' S. ?: l& Zalready witnessing surges in their unsold new homes at the
very time that the resale market has swung into strong
! D$ p0 c6 D' C, ~, {) {buyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
# S  `5 Q$ b" C! B1 \weakness, will be singed by the downturn nonetheless.
5 _* T7 D7 G. L8 z: f2 C) \- NQuébec shows signs of strain – especially given the
; J1 M# U4 i+ `, pstrange 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
rates. 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
4 [/ T0 z9 |* Y. }high levels of apartment-style units presently under
% M- c3 H5 i5 h. s: a: j! Qconstruction mean that record numbers of condos will
# P+ p8 @7 i# w( dreach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
/ Y4 K: C  N4 f2 k$ ]& rspike severely – particularly in Vancouver. However, while
residential construction in B.C. will definitely droop, we
$ _" U! o4 A$ p0 W# s- K, \anticipate that the West Coast will continue to benefit from
- x' L* P! ?* i# U& xinter-provincial and international migration over the coming
. k: [1 B( ~# l. k" z5 j  }5 kyears, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
1 \4 {4 V3 \7 k' N6 s/ HPascal Gauthier, Economist
416-944-5730

' _( I, f1 u: Jhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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