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
+ q* j! v4 A1 _4 O! }' lunsustainable levels of building. Our view is that house
prices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
2 \/ s  e. b8 q" H5 ~" A$ Foverpricing compelled a level of residential construction
1 p) ?  }+ r  x) Dthat 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
# l7 ~8 U( n. s; Atheir fundamentals, as witnessed by a steep erosion of
5 Q, b4 D, x& i+ S: ^% K, ~! r$ B2 {9 Jaffordability. The current unwinding of house prices reflects
: p2 x' \* U( ?# T3 sboth a cyclical downturn and a return of house prices
" W/ ~1 h9 c( N# B- Vto 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”
where 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
5 O. w( a0 \' R" tthat is now being rapidly reined in.
2 y" @4 Y+ A) kWhile most markets won’t face U.S.-style overhangs,
the construction of too many new homes over the boom
, V. T6 |/ {8 W+ |means a deepened slump. This overbuilding will likely weigh
- q* L% N& h/ g8 v; _; Gon markets over the next few years. Even as Canada recovers
/ s5 O& k# U' I. v$ x2 m& h/ q. xfrom the cyclical downturn, house price growth will
. [* p3 u0 t# Jremain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
. @. x& J$ J- f6 A' B. f# tis now undershooting fundamentals and we expect this
. A  v; B& y0 @1 H& ~) a$ @to persist over 2009 to 2011. We anticipate that nationwide
" I  ?% x4 ]4 k  [; d7 J& W; rresidential construction will fall further to around
5 ^. `9 k, z) _% U4 b1 T125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
To quantify the degree of overpricing and overbuilding,
we first develop an empirical model, based on long-run
" C) U7 e$ G# b1 S& X! gfundamentals of house prices and housing starts in each
/ x# J. k- k+ S+ J8 mprovince. Affordability is the key concept behind home
! k1 d( A  v: P, Nvalues since house prices should track incomes over the
8 O2 @. Y* G- H% N/ `8 vlong-run. Since homebuilders build to meet demand, we
regard housing prices and household formation as the drivers
of residential construction.
6 c& x! t) J4 B  E9 k; VTo examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
8 G* Q  R  @2 f" ?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.
Regionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
0 G2 f3 R. J' [' w2 E0 Ualready witnessing surges in their unsold new homes at the
very time that the resale market has swung into strong
buyers’ territory. Homebuilding in the Atlantic provinces
2 H, n# b! H1 i7 Bhas 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,
3 Z, [$ `4 S5 C, Tgiven the province’s history of under-building and low ownership
rates. While Ontario homebuilding will reel from a
7 m' s( T. S' n+ ocyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
( M3 T0 Q9 Z; ccondo market. Both in Toronto and Vancouver, historically
9 U0 ^7 u" ?4 \, S' chigh 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
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
years, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
& H9 M+ g) Y: F' i& \, \MARKET RETURNS TO FUNDAMENTALS
* l" \7 ?6 z2 L7 A2 eGrant Bishop, Economist
+ r/ f1 \; c; P416-982-8063
Pascal Gauthier, Economist
416-944-5730

' L5 s" Z3 R4 y0 B9 Zhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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