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
prices exceeded the value of housing that was justified by
7 ^( t1 ?% B& m0 M8 cfundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
9 ]8 Z# j+ O3 t) _0 B5 x. P9 u6 Fthat exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
three years.
& E9 N; \2 J' J% a" p* M2 DBy “overpricing” we mean that prices detached from
their 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
3 ?) a3 n2 D' v/ x* T  O+ B% T1 [to fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
5 [+ a5 R) v) Xthat this demand cannot be sustained; and “supply-driven”
' b. F5 }3 L5 G# _7 Dwhere builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
" z6 v' `! c$ V1 b- p6 c1 Thomebuyers 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
+ b% E) v, M3 k; W/ S% xmeans a deepened slump. This overbuilding will likely weigh
8 ^3 ~( O" L1 M' b  B5 A. O) {on markets over the next few years. Even as Canada recovers
# M3 ^  I5 P) I0 y6 ifrom the cyclical downturn, house price growth will
remain choppy and new residential construction will be
* y6 I+ J5 G' d- }6 mdampened, owing to this structural weakness. Construction
1 p5 |7 Z8 W' _2 a# b* t7 xis now undershooting fundamentals and we expect this
9 b6 E9 S; U2 H* Dto persist over 2009 to 2011. We anticipate that nationwide
5 x, T8 n* }$ ^( l/ Bresidential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
) c" K: o5 w. |6 ^in the fourth quarter.
To 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
* l4 ?0 G  E6 S8 ~  E2 m; q- O8 fvalues since house prices should track incomes over the
* ?# j* |* p/ ~  }9 Z3 Dlong-run. Since homebuilders build to meet demand, we
regard housing prices and household formation as the drivers
3 ?; U/ u! s3 |- Z4 a7 wof residential construction.
To examine the degree of overbuilding, we employ a
0 h$ o, E. W1 l$ n( Z) w“counter-factual,” asking what level of residential construction
$ b. N0 s% Y: Ewould have occurred if housing had been priced
; ?6 N1 u1 K! y" Z( ^# Roptimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
: Z# |: w9 P$ i- emany houses at prices that exceeded fundamentals.
, Q9 v% q5 h( A7 Q# h% i5 k4 u+ YRegionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
1 K# Y1 b8 |7 M# N9 p9 dalready witnessing surges in their unsold new homes at the
. T+ d3 o1 a7 L; ivery time that the resale market has swung into strong
; a  y2 h$ I/ X7 Y0 f  ^) a# K5 Y0 w2 ]; ibuyers’ territory. Homebuilding in the Atlantic provinces
$ L! a# E7 W, |1 q; J7 yhas been relatively balanced but, while not plagued by structural
: {, a  m" Z3 o  F/ X( g' w, ?* Q+ uweakness, will be singed by the downturn nonetheless.
* ~/ G8 h) s2 ~3 }; DQuébec shows signs of strain – especially given the
( E7 s- u1 d% t' A3 bstrange 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
0 z! E, @$ J/ p* C4 qlimited – with the important exception of the Toronto
0 n, u, V+ i0 W9 ]2 t& {condo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
construction mean that record numbers of condos will
& }* ^/ N& B- R- V( J/ Breach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
6 J% x0 O. _- sspike 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
( G/ ]4 q8 d4 g8 y; M9 Pinter-provincial and international migration over the coming
5 J, }( `& H" [% k4 E# ?years, which, along with improvements in affordability,
; O: @4 j4 y& Y& {+ w9 Y% Xwill alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
0 n% I! L7 a% ^) v: Q2 F; g6 rGrant Bishop, Economist
0 V/ a8 w" m. @& G$ [8 h8 r416-982-8063
Pascal Gauthier, Economist
5 T8 I  z4 u. Y5 x1 Y416-944-5730

  d/ D; m8 |7 @7 Q7 G# Qhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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