TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
: n+ P6 I: ]8 w" @4 Vfrom 2002 to 2008, unsustainable price increases drove
unsustainable levels of building. Our view is that house
7 ^7 c" Q/ @1 }  J+ Hprices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
( O1 }  }- ~+ n: Xthat exceeded its fundamental-justified level by approximately
$ Z. T, j: _% Z" R12%, an excess that was exaggerated in the past
three years.
By “overpricing” we mean that prices detached from
5 ]& K0 U% z0 Ptheir fundamentals, as witnessed by a steep erosion of
; Y7 I  b" O; y* ]9 laffordability. The current unwinding of house prices reflects
both a cyclical downturn and a return of house prices
0 P" z: t( L5 c( V9 Q; fto fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
% v% S0 |7 D% B  _. M& Ywhere homebuyers buy up too many houses and
7 c% }2 l* j( q8 r: qthat 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
6 ^6 a  [! x. h4 F2 Z“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
% j9 P0 _8 d% j! EWhile most markets won’t face U.S.-style overhangs,
. j, M; t& g6 z1 w- Jthe 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
) ?* H( ~& a  o# h5 [from the cyclical downturn, house price growth will
$ p8 f, {  `3 `! Bremain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
: u/ e7 B+ X4 Y% P+ Tis now undershooting fundamentals and we expect this
8 j* p: f$ o% {$ rto persist over 2009 to 2011. We anticipate that nationwide
residential construction will fall further to around
; B' P( a5 k; Q0 E9 B125,000 starts over 2009 with a trough around 115,000 units
5 Y, \8 F) z/ Hin the fourth quarter.
To quantify the degree of overpricing and overbuilding,
4 W" Q- w  @0 P) Q8 a- [. ]" A3 C& Twe first develop an empirical model, based on long-run
$ S0 Z% f% a9 d- p8 B, rfundamentals of house prices and housing starts in each
8 F( Z3 K6 u/ t: zprovince. Affordability is the key concept behind home
7 u# e' c3 B9 B$ z) kvalues since house prices should track incomes over the
8 g9 L! X  O4 B8 @long-run. Since homebuilders build to meet demand, we
regard housing prices and household formation as the drivers
+ [6 C1 N$ X& U2 Y* A9 eof residential construction.
4 m; l% V# W( Z9 Q5 j* F0 vTo examine the degree of overbuilding, we employ a
2 g9 m& `1 M1 V“counter-factual,” asking what level of residential construction
$ H4 |( [! g$ h1 r1 w, Z6 e+ _would have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
# g) V1 L2 @/ }  \* D2 lunits were being absorbed, homebuyers simply bought too
2 c4 U7 k" B& y4 |/ [many houses at prices that exceeded fundamentals.
" j) c9 z. O, q- {) ORegionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
" F0 x# E$ W* c6 S, s4 i; i6 W. l! Falready 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
has been relatively balanced but, while not plagued by structural
7 K$ ^! z# C% _) j" l7 fweakness, will be singed by the downturn nonetheless.
# H' s4 R0 O/ _( m, ^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
rates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
& g- d6 l8 H: X# b, ?limited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
0 r# s4 S4 \4 Q! T; d0 k9 r9 Ghigh 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
$ g2 V) H, i! zresidential construction in B.C. will definitely droop, we
anticipate that the West Coast will continue to benefit from
4 N" s  Y1 Z) c8 `8 Hinter-provincial and international migration over the coming
, A- y, }5 _. y* [+ nyears, which, along with improvements in affordability,
- i6 D1 z4 H( K6 `4 A) M% Dwill alleviate some of the pressure from overbuilding.
$ @1 H7 V, k+ t, k+ N8 O, _9 w0 {. YOVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
( |. ~# L6 w2 g9 K& ~416-982-8063
Pascal Gauthier, Economist
416-944-5730

+ \& E2 W  N) B2 ]  ~  Lhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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