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
9 G% Y# \; q- ofundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
) B# x2 s( p" g" ^8 h12%, an excess that was exaggerated in the past
, K. [) \$ c# o, a1 w/ [  Cthree years.
By “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
/ h) D8 p, R; i7 Maffordability. The current unwinding of house prices reflects
- k4 n2 b; e  h5 q. f( f5 Iboth a cyclical downturn and a return of house prices
to fundamentally justified levels.
4 i. R: K& B- yWe consider “overbuilding” of two forms: “demanddriven”
! D# c1 ^2 G" ~; f& h% `% W9 ?where homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
) L! D; F( N; lwhere builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
+ m5 I7 r5 ?$ [8 ]+ E1 dhomebuyers 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
means a deepened slump. This overbuilding will likely weigh
' r9 y0 N  F7 ?: \on markets over the next few years. Even as Canada recovers
' F: F1 _' M5 F" x7 Nfrom the cyclical downturn, house price growth will
remain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
  \8 [) k/ s) f- T  r/ dto persist over 2009 to 2011. We anticipate that nationwide
residential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
6 z% C( P1 F: r: x: b' `in the fourth quarter.
# A# e) u2 V- WTo quantify the degree of overpricing and overbuilding,
we first develop an empirical model, based on long-run
9 C6 i4 r0 W4 l- _% j3 ]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
long-run. Since homebuilders build to meet demand, we
( j2 X$ b% _& t$ h# c( w9 N8 Wregard housing prices and household formation as the drivers
/ ?1 H, |( e% W7 _' }3 qof residential construction.
To examine the degree of overbuilding, we employ a
3 z6 F7 h% }; ]" S“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
- l9 O& d* K- a8 v4 B* c: b1 O! goptimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
* ]% L! Z. F1 O: a4 [6 @/ J9 Lunits were being absorbed, homebuyers simply bought too
( s. s- [% i2 u- Umany houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
( s7 v- L8 [" H" q7 N6 B. Falready witnessing surges in their unsold new homes at the
- P- b( f9 `1 d5 L  ^% D* Y3 hvery time that the resale market has swung into strong
* @5 W4 P6 v7 C) W" Q! C) ubuyers’ territory. Homebuilding in the Atlantic provinces
. W* K4 |  S: vhas 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
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
& c- d& s& {& b, p5 r& trates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
  q  Q5 W% S# K  H$ D9 {$ I$ xlimited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
! x8 Q# b* h. |5 Econstruction mean that record numbers of condos will
( x8 C! N/ S! ^reach completion during 2009. If absorption rates fall, as
; i+ L+ M$ x( fcyclical factors would indicate, condo inventories could
spike 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
0 N* E6 G8 Y1 w5 x3 cinter-provincial and international migration over the coming
years, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
( Z9 w% ?  l2 _$ J6 I$ U# ]' c8 K% ROVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
+ k2 _7 [+ Q3 \& E7 w416-982-8063
Pascal Gauthier, Economist
. h4 P& {4 X/ @416-944-5730

, @/ m' o6 V+ x9 C* f( Mhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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