TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
3 C1 W! B6 ?2 sfrom 2002 to 2008, unsustainable price increases drove
5 l2 ?. e- W$ M  i/ F% _+ zunsustainable levels of building. Our view is that house
' I2 K# q$ _0 V- b. sprices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
) j; m* |1 f- wthat 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
their fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
! V, w4 |) R* L4 ]/ [8 aboth a cyclical downturn and a return of house prices
) r5 U8 n; _3 J4 uto fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
% A7 n  ~4 w& x( W* Vwhere homebuyers buy up too many houses and
7 P1 p) a' Y# r# _' Fthat this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
+ r/ [- h% y7 @9 t) R: V7 X“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
2 }/ {; p( Z, n& R1 p  ythat is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
! A" s% m" y, kthe construction of too many new homes over the boom
means a deepened slump. This overbuilding will likely weigh
on 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
is now undershooting fundamentals and we expect this
1 r2 C% P1 ?& F0 ~+ eto persist over 2009 to 2011. We anticipate that nationwide
" I; N- z- v9 z& _) Lresidential construction will fall further to around
1 X. v: Q& f' J3 z125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
/ X% z2 T" f$ `" t- |8 WTo quantify the degree of overpricing and overbuilding,
we first develop an empirical model, based on long-run
fundamentals of house prices and housing starts in each
9 E" P5 ^' z" Cprovince. Affordability is the key concept behind home
: V9 v6 v7 T/ Yvalues since house prices should track incomes over the
0 Z# G/ G6 x! }- F# R1 u& Plong-run. Since homebuilders build to meet demand, we
5 [" K4 O2 @8 Q- C1 t& e% zregard housing prices and household formation as the drivers
of residential construction.
To examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
7 V5 K% i1 R( d! Kwould have occurred if housing had been priced
. s6 j. G7 ^  e+ |7 koptimally. We find that actual homebuilding exceeded this
4 L- i- V) C, z# K; b: D3 L0 r' ffundamental-justified level by about 12%. Although new
" T: m( u* E2 |$ I5 dunits were being absorbed, homebuyers simply bought too
; z% u  o- o/ S; g9 V, Mmany 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
already witnessing surges in their unsold new homes at the
: b9 V! U6 E# F3 every time that the resale market has swung into strong
# k. e! b3 j" g" mbuyers’ territory. Homebuilding in the Atlantic provinces
! Q8 {& q" `' f& k, ohas 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
# M8 b: s3 ]5 t. _3 Arates. While Ontario homebuilding will reel from a
2 }3 j1 [8 P# R6 k# {cyclical downturn, the degree of structural weakness appears
0 M5 S$ r7 E: z% C) h3 alimited – with the important exception of the Toronto
$ j/ t2 }3 M3 |( V' F3 ncondo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
construction mean that record numbers of condos will
! k; b# U8 ?9 j) x+ i+ x. I6 freach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
. u7 x  x4 I6 O* [7 Dresidential construction in B.C. will definitely droop, we
anticipate that the West Coast will continue to benefit from
8 Y* v* ]9 y9 T( T, q( A1 einter-provincial and international migration over the coming
years, which, along with improvements in affordability,
0 @4 v* D' ]4 L. x  Ywill alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
+ D: b3 ?/ b1 W7 Y. n0 k- DMARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
$ C, `! {% H  C0 I' Q; \8 x8 b% o416-982-8063
# T( x4 K) b: W2 T9 QPascal Gauthier, Economist
416-944-5730

2 v9 o/ D; Q% @, [http://www.td.com/economics/special/gb0409_housing_exec.pdf

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