TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
4 o/ H7 w) m) W6 r7 X5 @from 2002 to 2008, unsustainable price increases drove
unsustainable levels of building. Our view is that house
' u* `- S+ \, `; y. z2 D3 U, Vprices exceeded the value of housing that was justified by
: z' {" l$ N! W4 U6 |- p0 nfundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
three years.
" J/ l" {; j" n1 X$ Y' ~' \' XBy “overpricing” we mean that prices detached from
1 t- ^7 `8 n; W( W6 K2 k$ qtheir fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
: i, D( C! p7 |both a cyclical downturn and a return of house prices
: _6 [& @/ D- d5 Q( y2 q" Pto fundamentally justified levels.
. \9 N8 R( t# T; P! xWe 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
( ~2 b9 I6 S% ?( r* b6 C$ _there is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
9 a! F0 s7 ~* g! f' E+ Q" Shomebuyers pushed homebuilding to an unsustainable pitch
' e! a# }3 R3 K: b+ Q& `that is now being rapidly reined in.
- r- H# s: h* a3 kWhile most markets won’t face U.S.-style overhangs,
: D0 o% J. {' s/ P/ ^% Fthe construction of too many new homes over the boom
means a deepened slump. This overbuilding will likely weigh
' X" o: ?* g: W% don markets over the next few years. Even as Canada recovers
from the cyclical downturn, house price growth will
2 M/ ~5 V& I% M; @remain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
& H" d$ B$ R  ~% ]/ N4 C9 X$ g6 }  pis now undershooting fundamentals and we expect this
! ^# q( X1 p5 u% ]/ I8 @2 fto persist over 2009 to 2011. We anticipate that nationwide
. v' p- L6 _& A7 S/ {7 `; F  A: Bresidential construction will fall further to around
0 Y1 C1 X+ Y6 M125,000 starts over 2009 with a trough around 115,000 units
) T; N6 S9 L. N+ e9 pin the fourth quarter.
) M* i2 A3 U8 m5 {To quantify the degree of overpricing and overbuilding,
we first develop an empirical model, based on long-run
1 I) ?% x* f, |; N2 P- t+ [, n0 Rfundamentals of house prices and housing starts in each
/ J' t4 J) H0 u: H/ s( Xprovince. Affordability is the key concept behind home
values since house prices should track incomes over the
long-run. Since homebuilders build to meet demand, we
regard housing prices and household formation as the drivers
! z" g8 g; Y% e' q0 Z7 R: Tof residential construction.
To examine the degree of overbuilding, we employ a
0 w! n6 S$ a: m- }8 F1 D( I“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
6 y5 d: O" _' i# a, pfundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
: Q& s5 a; l( ?1 i! z5 wmany 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
already witnessing surges in their unsold new homes at the
very time that the resale market has swung into strong
* W1 N% [) k  K  H2 _" {; [buyers’ territory. Homebuilding in the Atlantic provinces
1 u) `4 X% A4 Z  g9 l, h: [0 zhas been relatively balanced but, while not plagued by structural
weakness, will be singed by the downturn nonetheless.
/ O  D7 o& k4 ~5 P; aQuébec shows signs of strain – especially given the
4 A; F8 j, v3 O9 c% Hstrange accumulation of unabsorbed multiples on l’Île de
Montréal – but recent building has been relatively balanced,
7 F# U( a1 y5 e5 a$ z2 @3 Ggiven 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
& s2 n6 ~7 {' Dlimited – with the important exception of the Toronto
5 b3 U1 z+ Z  B9 Dcondo 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
- u- r3 V- n7 sspike severely – particularly in Vancouver. However, while
3 K! t* s6 k) j0 a+ X2 L7 x0 kresidential 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
% [* `5 f  ]! q; yyears, which, along with improvements in affordability,
) t! s' c- G1 h5 R3 a0 l. zwill alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
6 _0 m5 t/ y8 j7 M6 v4 x, t8 HMARKET RETURNS TO FUNDAMENTALS
6 C) A. M% e0 D' i  S+ i8 g0 YGrant Bishop, Economist
9 T. I8 m9 M) [$ y/ }; B& J! Q416-982-8063
Pascal Gauthier, Economist
416-944-5730

http://www.td.com/economics/special/gb0409_housing_exec.pdf

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