TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
0 q1 d% o& m  T4 ]2 }, T) Sfrom 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
fundamentals by approximately 9% nationwide. This
& q# k" v/ u. c& u7 `overpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
" u- n# z# A% U% o2 D$ Z4 Y- ^12%, an excess that was exaggerated in the past
three years.
: c9 q4 L; Y7 e( M/ ~7 I: BBy “overpricing” we mean that prices detached from
, ?/ K$ @5 \8 Ptheir fundamentals, as witnessed by a steep erosion of
  u( W3 [# Q6 N# p& a0 f/ qaffordability. The current unwinding of house prices reflects
both a cyclical downturn and a return of house prices
to fundamentally justified levels.
  V2 w0 I; L( c/ k6 aWe 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
( p, l5 m5 H' L6 othere is evidence of both types, we contend that Canada’s
8 A/ |# a+ |& |* c7 D“overbuilding” was mainly of the first type, where
- }$ }7 r5 x0 ^3 Q2 khomebuyers pushed homebuilding to an unsustainable pitch
8 s4 W# \) b1 Z1 L: E& {" dthat is now being rapidly reined in.
8 P' }( {+ Q$ }' yWhile 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
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
5 M8 B0 x1 }7 Rdampened, owing to this structural weakness. Construction
0 v7 e7 q) u, F) a0 u$ uis now undershooting fundamentals and we expect this
1 `  _/ w* P* V) c1 {; Yto persist over 2009 to 2011. We anticipate that nationwide
* j+ C9 Z* s7 [! g$ W) kresidential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
) Z2 _5 m- P3 j' Tin the fourth quarter.
To quantify the degree of overpricing and overbuilding,
% b1 U+ E1 l" f1 W+ w8 Q7 N9 O3 ywe first develop an empirical model, based on long-run
; X0 U. j1 H6 ]% k& R' F. v" \fundamentals of house prices and housing starts in each
province. Affordability is the key concept behind home
- x- u1 F) d8 f: e# @2 o4 t; q. tvalues since house prices should track incomes over the
  Y% K: \! @/ U+ ^+ {long-run. Since homebuilders build to meet demand, we
7 c( \: \  f1 X7 p* a, b) r$ bregard 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
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
many houses at prices that exceeded fundamentals.
. Z+ s9 g) e! s: d; ~! w2 h: H& LRegionally, we see the greatest strains on the Prairies,
. I5 v" E9 V/ [2 v5 X& Vwhere housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
: K4 E  C- L# Z- ?5 ivery time that the resale market has swung into strong
, E4 I6 ~* b* o. ]7 g6 p( k$ Zbuyers’ territory. Homebuilding in the Atlantic provinces
, ~1 g/ w: q$ dhas been relatively balanced but, while not plagued by structural
weakness, will be singed by the downturn nonetheless.
/ {3 v' @3 n" R. h' E& O7 |1 w5 qQuébec shows signs of strain – especially given the
strange accumulation of unabsorbed multiples on l’Île de
! E* t9 W" C+ j! Y! D& _. p0 [Montréal – but recent building has been relatively balanced,
0 s' M" M* b, L' P) b! }2 F) F+ dgiven the province’s history of under-building and low ownership
rates. While Ontario homebuilding will reel from a
# k7 R- M6 E+ Q6 V! G# t/ x$ E) N% \cyclical downturn, the degree of structural weakness appears
3 I: P- {7 ?- C% V: m' u3 S6 Tlimited – with the important exception of the Toronto
( x7 ?! E% n- v3 k9 M' _condo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
construction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
6 G6 ~: w9 P1 _spike severely – particularly in Vancouver. However, while
residential construction in B.C. will definitely droop, we
& N9 t; n* o& Panticipate that the West Coast will continue to benefit from
inter-provincial and international migration over the coming
4 s* h; G% m& d( U" e& [9 s# L0 Y" P) `years, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
. s  v, I- z* D/ j) Z$ v# h  {' t" mGrant Bishop, Economist
" j/ I- h; J* J7 L, f9 Z5 E" }416-982-8063
Pascal Gauthier, Economist
416-944-5730

1 G& p  q* E3 j( Chttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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