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
5 r9 R: r0 z" r5 ]5 v" P& oprices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
- K+ ~6 A) u% uoverpricing compelled a level of residential construction
  e5 `4 U2 [. P& i+ y0 u( Hthat exceeded its fundamental-justified level by approximately
0 N8 [# o/ p1 j$ H12%, an excess that was exaggerated in the past
three years.
By “overpricing” we mean that prices detached from
: U8 H( E' r' \* H! P- O3 t9 C' atheir fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
( N, }7 g& L0 B( C" A( _* aboth a cyclical downturn and a return of house prices
to fundamentally justified levels.
& j- q" z$ E/ N4 R+ c9 @We consider “overbuilding” of two forms: “demanddriven”
4 Y" r) c2 O3 Fwhere homebuyers buy up too many houses and
! m3 V% K% t; jthat this demand cannot be sustained; and “supply-driven”
$ z0 W. _( _" Hwhere 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.
While most markets won’t face U.S.-style overhangs,
7 ?5 @% d. g9 l% dthe construction of too many new homes over the boom
6 W! W. [6 C; @% u; Ymeans a deepened slump. This overbuilding will likely weigh
1 x! g, \* `" X$ N3 {7 A& _6 Z4 Gon markets over the next few years. Even as Canada recovers
8 N) \! ~  y$ l  c" Kfrom the cyclical downturn, house price growth will
remain choppy and new residential construction will be
2 [* G1 p) c4 E+ s% `1 odampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
5 Z" v  ?- y  K' ~residential construction will fall further to around
+ K/ T- `/ x; {/ s* Q) _0 X- y125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
. k3 q! X- N* r  zTo quantify the degree of overpricing and overbuilding,
we first develop an empirical model, based on long-run
& @9 w3 |3 \% W: [7 Y8 Ifundamentals of house prices and housing starts in each
% i0 v# B- a- V# n! \6 gprovince. Affordability is the key concept behind home
values since house prices should track incomes over the
! T% c/ H8 U, s' [/ J9 Zlong-run. Since homebuilders build to meet demand, we
regard housing prices and household formation as the drivers
of residential construction.
  I; I3 U9 |: n1 {0 L" DTo examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
: Y: w$ d. T3 h& U+ S3 R+ awould have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
  _6 Z) B8 j. u$ dunits were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
, N4 O. @: Q7 @where housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
* @- L  a) e, s1 Malready witnessing surges in their unsold new homes at the
3 J& {2 O: J0 w' T/ o7 b- Svery time that the resale market has swung into strong
  Q+ k, o2 {8 m- v( {- W) K6 mbuyers’ territory. Homebuilding in the Atlantic provinces
& m( e6 n( T# C2 s' V  \has been relatively balanced but, while not plagued by structural
weakness, will be singed by the downturn nonetheless.
$ E; Q- S/ c0 H3 U; J$ BQuébec 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
! K* i9 T4 p: w4 N, }rates. While Ontario homebuilding will reel from a
( j6 S7 i- ?+ O* T7 c* v1 hcyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
, z( w) Y# o8 X' T  Xhigh levels of apartment-style units presently under
0 S0 G/ u! N# y. @) ]construction mean that record numbers of condos will
' c1 c& y$ x. P# u2 S, Vreach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
- U# a, I( y6 J4 e* f* @spike severely – particularly in Vancouver. However, while
- G  P" D9 @* hresidential 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
+ n) R; {" `+ l; K4 j8 @years, which, along with improvements in affordability,
will 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
416-944-5730

# M- b  x& T' r) }5 D  Shttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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