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
/ }. o/ e( W9 a1 Sunsustainable levels of building. Our view is that house
prices exceeded the value of housing that was justified by
4 n% |5 i4 A8 Q* l8 E5 I( Bfundamentals by approximately 9% nationwide. This
$ k! T/ o( i1 qoverpricing compelled a level of residential construction
$ D8 a$ g9 v( X* f5 jthat exceeded its fundamental-justified level by approximately
, s$ d9 t  i& o8 b5 \12%, an excess that was exaggerated in the past
three years.
By “overpricing” we mean that prices detached from
; M9 ^5 S! V8 i  }3 Gtheir fundamentals, as witnessed by a steep erosion of
# y# W0 @- {7 K2 S) T! Q" a9 Oaffordability. The current unwinding of house prices reflects
both a cyclical downturn and a return of house prices
to fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
' l4 }' z) P, w# Q; _% Kthere 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
# R& F2 Y" Z! Z0 a' `that is now being rapidly reined in.
1 N3 |: L) `  h- JWhile most markets won’t face U.S.-style overhangs,
the construction of too many new homes over the boom
; N% O2 x# [$ C) H4 Pmeans a deepened slump. This overbuilding will likely weigh
7 X7 w5 A- j7 Y: J, O8 H6 xon markets over the next few years. Even as Canada recovers
; m. ]+ ]/ E9 }  B3 ffrom the cyclical downturn, house price growth will
) T% X- w% P) S2 X( p% F/ N" c+ Qremain choppy and new residential construction will be
. b) q" l/ v" K& V$ z' ^dampened, owing to this structural weakness. Construction
( h( v6 V! D, K- x0 J; O5 p# Bis now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
' i( R( ~( O6 G( c. R$ Cresidential construction will fall further to around
' x. w3 p5 V: ?- v, I2 `& O0 l# k125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
To quantify the degree of overpricing and overbuilding,
we first develop an empirical model, based on long-run
. T3 m& E7 p; g/ tfundamentals of house prices and housing starts in each
province. Affordability is the key concept behind home
6 N) v8 ~( f% U( a  a5 P2 s9 E5 X1 d0 ^values since house prices should track incomes over the
) {# h. W( g" O$ Ylong-run. Since homebuilders build to meet demand, we
) W& {: R9 X$ q  S8 Y8 Bregard housing prices and household formation as the drivers
of residential construction.
( T6 ^2 [# y) |% s) q- O1 fTo examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
* l8 M( N; E7 Q7 W9 dmany houses at prices that exceeded fundamentals.
  B; h& Y$ W/ {5 t$ PRegionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
8 I$ L& Z9 z* m/ K3 Ialready 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
has been relatively balanced but, while not plagued by structural
0 V0 _5 G3 [# d1 N( R/ Aweakness, 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,
: c' `5 o  g" Y4 w: ^0 g# A" c  sgiven the province’s history of under-building and low ownership
. x( a" R6 X' X9 \( @, D/ srates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
3 ?. n% s' t( A1 A3 r. Dconstruction mean that record numbers of condos will
6 X) w) [4 v# v$ @3 |reach completion during 2009. If absorption rates fall, as
3 [9 r# X& Z4 P( k% Scyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
residential construction in B.C. will definitely droop, we
. A% O$ `" ~8 E' P( Canticipate that the West Coast will continue to benefit from
# O# B9 ?  Y& i( [inter-provincial and international migration over the coming
( y* X. z; z" m, T* l2 x: Cyears, which, along with improvements in affordability,
6 Y! D! h3 i& `: z8 a2 `will alleviate some of the pressure from overbuilding.
5 L  t  `. m0 qOVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
2 r& P* X- u2 q% h/ I, f' rGrant Bishop, Economist
3 F9 ~$ I/ }/ U: E+ O416-982-8063
  P, g, [, u/ R8 X: ?8 [$ {Pascal Gauthier, Economist
- V2 h' ~. f2 z, y* A416-944-5730

8 z$ t& I4 E$ ]http://www.td.com/economics/special/gb0409_housing_exec.pdf

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