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
fundamentals by approximately 9% nationwide. This
  W% A, a! g( i1 J4 F1 coverpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
2 s" n' v$ T+ T2 J  d  r$ ?7 D8 Q12%, an excess that was exaggerated in the past
6 D; G7 ^+ u6 S$ w6 Mthree years.
4 }, ~' o% Q5 |6 l  U9 ~  WBy “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
( Y8 N) X$ N$ G  f' p6 Haffordability. The current unwinding of house prices reflects
+ z1 h2 R9 o) Z% Q6 }' [both a cyclical downturn and a return of house prices
to fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
8 e+ p( Z3 U7 q  K* X& tthat this demand cannot be sustained; and “supply-driven”
& D7 [5 E" g; T6 w6 gwhere 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
that is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
the construction of too many new homes over the boom
! }9 Y; Z' d0 k7 U0 V! _means a deepened slump. This overbuilding will likely weigh
on markets over the next few years. Even as Canada recovers
  P6 B$ K! p3 I) {from the cyclical downturn, house price growth will
$ H1 Y0 [' M! ^7 v' |  Aremain choppy and new residential construction will be
3 `$ f' e7 T. c. p* G$ P8 qdampened, owing to this structural weakness. Construction
& o" Z& w& R8 R: l( eis now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
9 ?3 `! x7 A' Aresidential construction will fall further to around
* I/ B2 D0 s8 w& \/ O0 p6 v125,000 starts over 2009 with a trough around 115,000 units
2 E0 T$ R4 [! Y0 Y* N8 L3 y% sin 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
/ P' R; _2 z# L6 a+ a  Yprovince. 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
of residential construction.
! O, K0 r6 D2 `2 NTo examine the degree of overbuilding, we employ a
2 R/ ?- p7 l$ P* P“counter-factual,” asking what level of residential construction
/ A5 A3 I7 w+ O+ M. @1 fwould have occurred if housing had been priced
; \. V6 v3 v) k9 u8 g% a$ w0 u8 Woptimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
; [* B- \. z6 O$ Xunits were being absorbed, homebuyers simply bought too
# Z  ?0 ^+ O4 Qmany houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
7 z9 |9 o* H* e- l/ R+ L$ x  @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
  P: U5 L- t. x; b; j' S5 r. ~1 tbuyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
* G2 g9 a6 U: l+ D2 Nweakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
, H4 n) L: E# Z( Z; o1 Dstrange accumulation of unabsorbed multiples on l’Île de
Montréal – but recent building has been relatively balanced,
8 I/ s. h% e& `5 u5 @" A" Pgiven the province’s history of under-building and low ownership
rates. While Ontario homebuilding will reel from a
- z* X. l- x7 z0 ?3 D3 [cyclical downturn, the degree of structural weakness appears
2 H3 z1 U1 ^; \; q5 L+ ]limited – with the important exception of the Toronto
' i9 w% q, V2 p; f8 w9 _condo market. Both in Toronto and Vancouver, historically
; E% V: i8 @! W1 chigh levels of apartment-style units presently under
- m" a( s4 B( G1 E5 v. d  x; Zconstruction mean that record numbers of condos will
. i$ \  a. k7 }+ c2 b" Breach completion during 2009. If absorption rates fall, as
8 Y7 I6 S7 e+ J0 |3 i! ]8 Gcyclical factors would indicate, condo inventories could
& N, u9 d: z  l- M: hspike 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,
  J' h9 Z2 q: j* J8 C7 Uwill alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
. ?# e7 Z% j2 Q1 e3 J4 jMARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
! G" @" K/ }& b# \  }9 I6 J0 wPascal Gauthier, Economist
416-944-5730

+ k# B5 v/ f( O8 c1 {http://www.td.com/economics/special/gb0409_housing_exec.pdf

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