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
unsustainable levels of building. Our view is that house
) Q& Y7 o. m+ K2 ]4 Uprices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
' Y/ n1 Y; s5 xthat exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
. e: A2 h( ^: Q( _3 Ithree years.
1 z6 L& v6 E, a  \By “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
( p) a* \( C: F. O2 }1 n! waffordability. 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”
8 [1 p* h* u# {! R4 ~where homebuyers buy up too many houses and
8 `" t: r! ?. D1 ^7 f& }that this demand cannot be sustained; and “supply-driven”
6 H  _: U6 p7 ^- E2 E" wwhere builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
, g! b" {+ ~1 I6 Khomebuyers pushed homebuilding to an unsustainable pitch
7 a: e7 ]  {2 ^% D8 Y! B% P( d: o) Othat is now being rapidly reined in.
# s+ q3 e$ [$ G5 M# _0 R2 CWhile most markets won’t face U.S.-style overhangs,
the construction of too many new homes over the boom
5 K6 g8 O8 W3 C/ jmeans a deepened slump. This overbuilding will likely weigh
: J: c; X2 M# Y9 O; \: @, kon markets over the next few years. Even as Canada recovers
/ m+ s- x8 R; Zfrom the cyclical downturn, house price growth will
; U, k1 Y" j7 p, Fremain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
- L9 D1 q4 h3 R8 v% y+ Eis now undershooting fundamentals and we expect this
6 ~: }. ~4 a0 b! T* r, h) ^to persist over 2009 to 2011. We anticipate that nationwide
2 H, r  e+ b$ `0 Tresidential construction will fall further to around
+ @+ R) A% w- x2 U( \. M125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
0 N$ x! m9 ^! t5 o# KTo quantify the degree of overpricing and overbuilding,
we 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
, Q7 X. ]$ _: l# c6 V$ J5 ]values since house prices should track incomes over the
long-run. Since homebuilders build to meet demand, we
3 r- b: U. U" ?" f. x( |9 yregard housing prices and household formation as the drivers
& ]2 O4 b. l) Vof residential construction.
3 }" f" s7 L0 q% i, z2 FTo examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
: t! Z& m* O/ f, ~4 \. w3 |" B# {' ~would have occurred if housing had been priced
1 y4 n# \0 W+ u: o) Toptimally. We find that actual homebuilding exceeded this
& {! i5 q) y  w, u7 i/ Ffundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
! e* U/ l5 y9 {" V; ~) a; k. umany houses at prices that exceeded fundamentals.
6 m2 E  u) P8 ^% U" a& F) g  NRegionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
" ?2 @/ D$ y4 G8 m6 r$ O& D) npopulation inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
; m2 b- V4 O$ y# \very time that the resale market has swung into strong
buyers’ territory. Homebuilding in the Atlantic provinces
5 d1 Q& h% S6 s& Z; A3 c6 R% Bhas been relatively balanced but, while not plagued by structural
weakness, will be singed by the downturn nonetheless.
  z9 I" |: }: I4 @% FQuébec shows signs of strain – especially given the
3 ?8 s  |& x; `4 ^& X& Istrange accumulation of unabsorbed multiples on l’Île de
Montréal – but recent building has been relatively balanced,
# k3 Q+ k3 l% Bgiven the province’s history of under-building and low ownership
rates. While Ontario homebuilding will reel from a
2 j3 a$ @7 ?( V0 K1 Tcyclical downturn, the degree of structural weakness appears
! O2 o; F2 h5 \* f3 ylimited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
8 l9 F; K5 L1 ]high levels of apartment-style units presently under
construction mean that record numbers of condos will
& i( [/ b7 Q' {! r3 o+ m& s: ureach completion during 2009. If absorption rates fall, as
  m+ p! [2 Q8 @3 Zcyclical factors would indicate, condo inventories could
4 y* }( m/ o' b7 Vspike severely – particularly in Vancouver. However, while
residential construction in B.C. will definitely droop, we
anticipate that the West Coast will continue to benefit from
5 \. `7 r' x: u: z# [$ r2 zinter-provincial and international migration over the coming
years, which, along with improvements in affordability,
2 \1 Z3 t  x9 Iwill alleviate some of the pressure from overbuilding.
; ~# I" P0 ^. g+ w9 t; q, }8 S  sOVERPRICED AND OVERBUILT: CANADIAN HOUSING
. y# u2 l2 L& Y: k% ?MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
$ s) J6 \, u$ `+ O6 w416-982-8063
Pascal Gauthier, Economist
# t# r: P/ ^5 J+ V416-944-5730

) a0 g, h( E- t" g9 _# `9 I4 a# Khttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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