TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
7 R5 b$ S4 |; V. Yfrom 2002 to 2008, unsustainable price increases drove
unsustainable levels of building. Our view is that house
" v$ C2 V9 v* ]9 Gprices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
" `0 |" z' t8 B3 L; Ethat exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
three years.
: @% u4 B9 ^' l* K: @# |; S  P" M/ n! WBy “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
& s5 R3 ?! ]% ~  N7 Maffordability. The current unwinding of house prices reflects
9 ?: h8 l; _. z/ j! D2 C7 pboth a cyclical downturn and a return of house prices
to fundamentally justified levels.
' n* G1 n5 A) J: \+ H# \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
9 s2 }' h& T. vthere is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
! P. T6 M' ~$ n3 E5 ~homebuyers pushed homebuilding to an unsustainable pitch
5 `/ W& f% G8 ~. e5 t8 i! mthat is now being rapidly reined in.
* n$ I4 J9 d4 ?  d% T* I; pWhile most markets won’t face U.S.-style overhangs,
* {* {7 T$ b- R1 F( t0 sthe 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
, u6 G$ V5 \; o0 j0 v% Iremain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
$ k+ Z' C" ~: H9 {8 ?6 ]  \' Jis now undershooting fundamentals and we expect this
  m6 B6 M& U$ B; R/ Kto persist over 2009 to 2011. We anticipate that nationwide
residential construction will fall further to around
' d' U8 R1 D  [. V& I+ N125,000 starts over 2009 with a trough around 115,000 units
6 z. u: m% G* z0 D4 y' y4 win 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
values since house prices should track incomes over the
3 t6 t8 A7 q1 _8 \8 H! F; I# @long-run. Since homebuilders build to meet demand, we
9 D; Z  P9 z, d+ }1 ~6 A- w- b  Vregard housing prices and household formation as the drivers
of residential construction.
' l7 M  `7 v8 y. B) G& V3 e5 W; R6 OTo examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
. B' Y+ G, \# Z/ q) V" I* Jwould have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
# x) h  d/ j$ W2 y: e% Y- G- Jfundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
$ f7 Q7 u3 ]" @6 r. T0 upopulation inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
very time that the resale market has swung into strong
! q  o+ r; w2 Z7 ^$ abuyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
weakness, will be singed by the downturn nonetheless.
9 L* K8 x  p. H' a6 B2 m/ HQuébec shows signs of strain – especially given the
strange accumulation of unabsorbed multiples on l’Île de
Montréal – but recent building has been relatively balanced,
+ ^: s9 Y4 Y2 d/ d4 ]& F* cgiven the province’s history of under-building and low ownership
rates. While Ontario homebuilding will reel from a
. V4 T3 U8 M+ Z" i5 T! c/ Vcyclical downturn, the degree of structural weakness appears
; S( W# `7 t9 ]8 j& Glimited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
) R( Y7 i' C7 e5 t2 j& p. aconstruction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
2 R7 T/ _% V/ \2 m5 x+ lcyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
residential construction in B.C. will definitely droop, we
anticipate that the West Coast will continue to benefit from
$ S( u; x) Y# Dinter-provincial and international migration over the coming
years, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
( \0 E/ S; D0 T7 W& TOVERPRICED AND OVERBUILT: CANADIAN HOUSING
1 F* U8 l$ x* o3 Y4 P/ J9 b" NMARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
/ }! G9 k; p' S416-982-8063
Pascal Gauthier, Economist
416-944-5730

) B3 G, O% ?0 N/ ]$ s: J6 phttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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