TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
5 g. c/ Y. C6 c& ]. ^: qfrom 2002 to 2008, unsustainable price increases drove
" ~" R5 N( @" H! y. y0 `+ {4 _9 Lunsustainable levels of building. Our view is that house
prices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
. v5 Z$ o1 J7 ]* _/ voverpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
8 b% o  R  W4 V+ O8 H5 G& xthree years.
By “overpricing” we mean that prices detached from
: B% Z- i5 w. C% G/ d: f- utheir 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
6 z# i0 I: y: _' f! N, Xto fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
& N! B6 Z" K% M  `where homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
- x6 I( K& Y; a0 J9 n% `) |where builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
' L5 W4 ^* x7 N" [% ]$ yhomebuyers 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
. y  U" M1 ]( g* N$ k# K9 ?means a deepened slump. This overbuilding will likely weigh
, _2 g  W8 R1 Zon markets over the next few years. Even as Canada recovers
! `, ?1 V9 i) s9 b  u9 ^+ gfrom the cyclical downturn, house price growth will
remain choppy and new residential construction will be
5 B' c( K' B) n2 b' B0 udampened, owing to this structural weakness. Construction
( E2 t* F5 ~7 Uis now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
4 A# z: n! m( Vresidential construction will fall further to around
9 Z- X- ~- n$ e125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
! {/ F' N1 `7 ?% _8 E7 L  m5 s+ BTo quantify the degree of overpricing and overbuilding,
we first develop an empirical model, based on long-run
9 b$ M3 P6 _1 l: ]& `$ |fundamentals of house prices and housing starts in each
province. Affordability is the key concept behind home
values since house prices should track incomes over the
4 ]4 @7 t- F' Y& {5 e  h' ^2 Llong-run. Since homebuilders build to meet demand, we
regard housing prices and household formation as the drivers
  l# t4 t# E! ^of residential construction.
To examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
0 ]6 o+ G$ j; ?, \2 c2 `would have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
: x8 P& }0 e# cunits were being absorbed, homebuyers simply bought too
. L! k. c8 \+ P/ u" V% {( k: Emany houses at prices that exceeded fundamentals.
, k" {2 q# }& B- p" M; h4 {( q4 vRegionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
: T6 u( q! ~$ v$ P, S3 X4 ipopulation inflows. Saskatoon, Calgary and Edmonton are
1 p& \6 p1 \( G& c8 U- ]. walready 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
: W$ g4 a" J" T0 @$ U. c8 zhas 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
7 S) P3 r% Z) s4 J0 lstrange accumulation of unabsorbed multiples on l’Île de
Montréal – but recent building has been relatively balanced,
1 J, n* p; d; A# F6 t% Wgiven the province’s history of under-building and low ownership
& q8 o  ?4 o7 }) O. k$ O# Q- j( nrates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
$ z* Q3 |' m2 Qlimited – with the important exception of the Toronto
9 T' F+ R7 ?/ S! V9 e  I0 Dcondo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
construction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
4 \7 ?2 R2 v6 r5 P6 n  D5 Kcyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
$ i5 s  m9 z; i' bresidential construction in B.C. will definitely droop, we
7 ^( S3 k4 U" ]6 Santicipate that the West Coast will continue to benefit from
inter-provincial and international migration over the coming
years, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
  e9 f5 S. O5 l5 TGrant Bishop, Economist
1 Z$ ?; |$ @+ d5 M7 j* n4 V416-982-8063
Pascal Gauthier, Economist
416-944-5730

4 C3 z; K: o' C5 X" Thttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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