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
( L0 P/ z9 t3 t9 ~9 s2 u" b9 dfundamentals by approximately 9% nationwide. This
+ t3 D( {: F4 U% foverpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
three years.
By “overpricing” we mean that prices detached from
# \* v' A& Q2 i5 B6 i. j8 F) atheir 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
; F$ L5 G/ i2 ?to fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
- c' ?0 x' e: ?* \- ~; Jwhere homebuyers buy up too many houses and
2 u  }  i" D, @: S- Kthat this demand cannot be sustained; and “supply-driven”
: v% e. M( |5 jwhere builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
; b+ j( c- s' ^2 x& t& F0 X  mWhile most markets won’t face U.S.-style overhangs,
9 S- b: o- t0 `/ D. U8 [6 U9 Ethe construction of too many new homes over the boom
- @. x6 e& ?/ e: O& U0 w* D9 l" Gmeans a deepened slump. This overbuilding will likely weigh
# U& @+ J* r3 e$ Pon markets over the next few years. Even as Canada recovers
" ]6 s  `& F( v* x+ l8 g- Yfrom the cyclical downturn, house price growth will
( l2 a2 Q$ J& B- j5 Wremain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
: l. }! B+ Z: Sresidential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
+ }3 j/ `/ z8 ~& G1 N- HTo quantify the degree of overpricing and overbuilding,
3 ^, w; `. t/ T6 cwe first develop an empirical model, based on long-run
6 s; P" u9 _5 @  i* P7 `fundamentals of house prices and housing starts in each
9 H4 h( ]7 O# L% J/ c; \province. Affordability is the key concept behind home
8 c+ X9 U) _6 l# A* I2 bvalues since house prices should track incomes over the
) b* @0 h6 P" t+ Z& F# r) Ulong-run. Since homebuilders build to meet demand, we
7 s' g; B: z/ Y6 }/ z  }/ Fregard housing prices and household formation as the drivers
of residential construction.
* o) ~) V; w0 a2 l+ MTo examine the degree of overbuilding, we employ a
0 _6 s9 o% P6 M$ ]7 _6 i“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
2 _7 l3 l' p+ l5 Zfundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
  j3 V4 r2 U6 J4 E$ vmany houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
7 ~" E- v" a8 vpopulation 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
3 g0 |. c& {6 }) ?& y: P; g9 Pbuyers’ territory. Homebuilding in the Atlantic provinces
1 g, I  l. [) S! thas been relatively balanced but, while not plagued by structural
weakness, will be singed by the downturn nonetheless.
) o1 I1 E, v* v: j- _Québec shows signs of strain – especially given the
strange 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
* q5 I5 x! H  }5 _! C* Lcyclical downturn, the degree of structural weakness appears
: R# l) s* |" l' Blimited – with the important exception of the Toronto
9 @* |& i* R9 J; K, c/ ycondo market. Both in Toronto and Vancouver, historically
+ T' I5 b' N, D% A- f# E9 u! rhigh levels of apartment-style units presently under
8 J$ p. [: @- Q3 y# d6 }construction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
7 @+ q% C$ N% Ocyclical factors would indicate, condo inventories could
7 K, y; ?: ^9 \" Q8 y( ~) F0 I* Q- Cspike severely – particularly in Vancouver. However, while
) j' S* g: _( s. H/ C8 J! ]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
years, which, along with improvements in affordability,
) c' q. U$ ~8 z4 U" R1 ywill alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
Pascal Gauthier, Economist
7 r- K  R  e3 r/ n0 x416-944-5730
9 m1 i/ n7 q: B' W
8 h7 z( y( d* c9 M7 y9 Yhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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