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
) h- u8 a5 t/ ?% P6 z  gunsustainable levels of building. Our view is that house
prices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
0 I, |! u6 B. k+ S# H* |3 q% c" Ooverpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
: E) @% }1 `) y9 t% r9 n% Y) g) n# j; t12%, an excess that was exaggerated in the past
/ e! y; t, |. J/ Q& J3 ?2 z0 P+ F/ p9 O  zthree years.
: {0 s% b" O3 YBy “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
$ s) u! a8 d7 W" w$ r* sto fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
# L5 m! _8 I: Wthat this demand cannot be sustained; and “supply-driven”
$ v/ g: H) V$ Q- jwhere builders accumulate excessive inventories. Although
* X8 g8 I" x: r* g7 O$ lthere 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
! g+ C! \" B6 @5 l  ~that is now being rapidly reined in.
5 \; r& J7 ~& d( o9 O8 yWhile most markets won’t face U.S.-style overhangs,
: r: v( i3 k5 gthe construction of too many new homes over the boom
means a deepened slump. This overbuilding will likely weigh
6 R1 X  R! Z7 R1 Ion markets over the next few years. Even as Canada recovers
from the cyclical downturn, house price growth will
remain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
" v' _; m2 ^) ~1 q6 w  @8 Kis now undershooting fundamentals and we expect this
& Z* i/ I) ?$ p0 E3 ito persist over 2009 to 2011. We anticipate that nationwide
residential construction will fall further to around
7 [, [! Z( N! J7 k1 m, \125,000 starts over 2009 with a trough around 115,000 units
9 P5 Z3 C( C& y: d& b9 t! `  tin the fourth quarter.
To quantify the degree of overpricing and overbuilding,
we first develop an empirical model, based on long-run
! \5 w2 k& y# M5 y' s+ Rfundamentals of house prices and housing starts in each
province. Affordability is the key concept behind home
  \2 K9 I1 S4 A! z: U* N6 ~+ {values since house prices should track incomes over the
9 _7 G) v% M5 h( x$ F! @( Elong-run. Since homebuilders build to meet demand, we
( F* v$ z% n$ F0 Mregard housing prices and household formation as the drivers
of residential construction.
; N$ O( B- V7 J6 v2 sTo examine the degree of overbuilding, we employ a
/ I# b5 A5 |7 G# c5 b( A, r; ^8 L“counter-factual,” asking what level of residential construction
5 u7 T* w. e* a- ]* O) l. mwould have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
  W! c6 A, K% J& ^& [0 Hfundamental-justified level by about 12%. Although new
- k" ^7 h$ h+ ?# }9 @9 hunits were being absorbed, homebuyers simply bought too
, G9 W  p7 |# Q4 @" n: }# omany houses at prices that exceeded fundamentals.
- W* ^6 C* r- h+ P9 y- c, ORegionally, we see the greatest strains on the Prairies,
1 X. c0 j* U" O. twhere housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
3 M, g" R$ t. d6 `: P; ^6 J( kalready witnessing surges in their unsold new homes at the
/ J) l# M) Z" A) wvery time that the resale market has swung into strong
buyers’ territory. Homebuilding in the Atlantic provinces
: x: B# N8 T1 h7 Q& V5 \* L8 Chas 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
$ z" x, V9 A8 Bstrange accumulation of unabsorbed multiples on l’Île de
7 Y! g. O; e" G5 W8 o8 I* h( TMontréal – 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
, R$ D4 f2 l$ Y- V- |- Ycyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
/ S/ S( \/ [* B: z! k  x4 Mhigh levels of apartment-style units presently under
construction mean that record numbers of condos will
/ n  u1 [+ X+ r! Z% b; nreach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
* h* J. ]; d2 wspike severely – particularly in Vancouver. However, while
, N6 ^9 K9 F1 w$ b) w% _/ xresidential construction in B.C. will definitely droop, we
2 I2 {/ q5 ]! W: y1 G2 }5 aanticipate that the West Coast will continue to benefit from
inter-provincial and international migration over the coming
years, which, along with improvements in affordability,
. m# u# L7 a, ~6 N, O# Iwill alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
7 a/ h0 J$ D& x) A' N0 yMARKET RETURNS TO FUNDAMENTALS
, j; l6 L; \/ t; w1 T- ?- l$ Y# DGrant Bishop, Economist
  L, I2 H* y0 \0 T) i9 n2 H416-982-8063
Pascal Gauthier, Economist
+ z: V) D1 \4 a8 Z6 i416-944-5730
% X! d+ S, S) ?) u/ O
: D6 X& t7 X, l( e# q( ~+ Nhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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