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
unsustainable levels of building. Our view is that house
prices exceeded the value of housing that was justified by
3 K8 i) F. O. E0 F! H8 Lfundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
7 r9 S8 U. A4 `1 m. |  B6 Bthat exceeded its fundamental-justified level by approximately
6 M) h6 x0 L+ l7 G* D/ T12%, an excess that was exaggerated in the past
three years.
By “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
% Z  W2 u1 R& n( N# |# s$ @affordability. The current unwinding of house prices reflects
4 s* u0 h5 \1 K6 R: x5 ~both a cyclical downturn and a return of house prices
to fundamentally justified levels.
7 @2 y% ]- i2 G- o9 l& tWe 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
% S1 y" j/ |  c; B% ?9 vthere is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
  K" [- @/ R5 e# Vhomebuyers pushed homebuilding to an unsustainable pitch
1 ?, z( U& r; I( \+ U. Ithat is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
* @& ~" n8 F4 N2 R' B7 W% X. mthe construction of too many new homes over the boom
2 Z0 W7 r: l; Vmeans 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
dampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
( ~- k! h5 j/ J9 s* t' D4 Tto persist over 2009 to 2011. We anticipate that nationwide
& V: j; g4 I9 k) ^: \residential construction will fall further to around
; h. J. F6 o+ b: D5 `) u) e+ O1 i125,000 starts over 2009 with a trough around 115,000 units
7 L# ?& i. d. ^( G  b( R5 n% ]) ?7 Ain the fourth quarter.
$ I2 w5 ~1 J0 LTo quantify the degree of overpricing and overbuilding,
we first develop an empirical model, based on long-run
6 o1 [6 [" M1 c: ^+ Kfundamentals of house prices and housing starts in each
! D$ w4 o# Q+ q) d0 G5 J  T) nprovince. Affordability is the key concept behind home
values since house prices should track incomes over the
  r' j- R' c! b' z* h9 j1 f$ {* t9 glong-run. Since homebuilders build to meet demand, we
( }6 W3 T% s! L5 w: X$ y5 Z+ ?6 wregard housing prices and household formation as the drivers
9 L: _( \3 d. }4 f$ ^; k0 Pof residential construction.
0 M: b. C  J* ]0 P1 X/ DTo 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
: T7 t( J# Q1 J+ ?! @" nunits were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
4 Q( |' e, S. I( a8 T* i- DRegionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
. w# q& _0 n3 J3 r0 m& zalready witnessing surges in their unsold new homes at the
9 Y% ~6 B7 U# V7 tvery time that the resale market has swung into strong
, f( |! J$ P; Cbuyers’ territory. Homebuilding in the Atlantic provinces
, k8 E* c4 a& ]* q- y- e; k6 ]5 `has been relatively balanced but, while not plagued by structural
weakness, will be singed by the downturn nonetheless.
* b4 t5 a) `3 F0 zQuébec shows signs of strain – especially given the
7 |- m; B" M$ u9 [6 s  Estrange accumulation of unabsorbed multiples on l’Île de
6 b7 ~( `$ V8 m  sMontréal – but recent building has been relatively balanced,
+ x. Y4 T6 W6 Jgiven the province’s history of under-building and low ownership
. [9 y, ?! ~  a, h, t3 g3 f7 [6 jrates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
! F4 g' t" y3 K% |6 Glimited – with the important exception of the Toronto
$ B& y! D3 \/ Y& O5 ~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
1 `; U3 y4 R* i$ e, Cspike severely – particularly in Vancouver. However, while
1 ~- X) f# F  p3 n  aresidential construction in B.C. will definitely droop, we
anticipate that the West Coast will continue to benefit from
2 y+ h1 O/ E3 f. [* l/ s- k! F2 _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
MARKET RETURNS TO FUNDAMENTALS
, r. j4 N# `, |! o" t9 bGrant Bishop, Economist
416-982-8063
: E0 o. A% u) }7 r) J6 ^+ vPascal Gauthier, Economist
/ \2 O! N% }, @& R) g: J416-944-5730
8 A4 X- D* B# ^  M' ]
) U- X5 z0 e8 E: V' _. }http://www.td.com/economics/special/gb0409_housing_exec.pdf

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