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
- z2 R, p8 c* n. V/ G# Gunsustainable levels of building. Our view is that house
prices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
, ~4 S! v( H  g# O, G. @  vthat 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
3 l$ v9 ~4 j( w- u4 dtheir fundamentals, as witnessed by a steep erosion of
; W+ [2 Y5 T' k3 s( q8 g  Yaffordability. The current unwinding of house prices reflects
& E5 V, ~! b# z0 q; W# pboth a cyclical downturn and a return of house prices
/ L1 h5 M, u6 O( U* z, [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”
0 ~# x/ A1 b; g; z( Ewhere builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
" X( `# v8 s6 s$ r" R“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
' m0 s. L5 C& R1 k; X0 Kthat is now being rapidly reined in.
' h1 O6 r" ]; g/ ]: dWhile most markets won’t face U.S.-style overhangs,
1 m* O% M8 j0 v0 l( V) mthe construction of too many new homes over the boom
means a deepened slump. This overbuilding will likely weigh
! S4 s* \5 C  fon markets over the next few years. Even as Canada recovers
' h: q7 l$ t7 A2 W: efrom the cyclical downturn, house price growth will
remain choppy and new residential construction will be
3 d& g& s& D; y* @4 J( R. {dampened, owing to this structural weakness. Construction
. n6 K" T- I; ]' o4 S4 Tis now undershooting fundamentals and we expect this
to 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
, \5 i2 |+ z% V$ d: ein the fourth quarter.
To 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
province. Affordability is the key concept behind home
5 a) \4 p4 l* l6 b  Y" q% t4 Qvalues since house prices should track incomes over the
7 J- V) H3 p& K$ I/ G5 z! x) a( q" clong-run. Since homebuilders build to meet demand, we
regard housing prices and household formation as the drivers
" }( q: \7 i! H. ^9 Cof residential construction.
. D7 A4 y+ h* \6 |To examine the degree of overbuilding, we employ a
! j* _5 T4 L- f" M- U! Y6 R; F“counter-factual,” asking what level of residential construction
+ f& d3 A. w5 f9 [% |3 Ewould have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
9 V# e9 `4 G! `6 X- jfundamental-justified level by about 12%. Although new
3 E' G) W. d! n  U( W4 @" Ounits were being absorbed, homebuyers simply bought too
1 y+ F# b. R; E, e4 \many houses at prices that exceeded fundamentals.
0 [1 O6 o1 c/ p; \4 @2 k4 wRegionally, we see the greatest strains on the Prairies,
  D5 L0 k7 |- Iwhere housing demand will further contract under waning
# q# m/ I# A7 z9 bpopulation inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
& D2 t" z" v$ i6 f2 C, ~very time that the resale market has swung into strong
2 }# w5 t8 Y6 obuyers’ territory. Homebuilding in the Atlantic provinces
/ Q' R8 _1 |# H+ R6 ^6 k, {# ahas 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
. x" e, }. `$ t; _, z- vMontréal – but recent building has been relatively balanced,
given the province’s history of under-building and low ownership
rates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
- N) y! N6 J/ \/ F# flimited – with the important exception of the Toronto
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
spike severely – particularly in Vancouver. However, while
6 z$ {; v( x+ d8 ~residential 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
) Q7 l, V! C, E" Iyears, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
6 h& M6 |2 o0 F- }- L8 sOVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
4 `* x# H0 T9 @416-982-8063
Pascal Gauthier, Economist
/ |: A- Q( z6 {1 z8 i" `416-944-5730

5 w  Y$ M' l2 {) Yhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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