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
, M6 C! i4 Z6 pprices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
7 W. R) b) z% H$ |* h5 Nthat exceeded its fundamental-justified level by approximately
& |# r( t$ ?, K4 J* O, M, p12%, an excess that was exaggerated in the past
three years.
By “overpricing” we mean that prices detached from
, w+ t2 O, h& d# n8 d5 z9 ztheir fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
both a cyclical downturn and a return of house prices
' }6 k) U5 W$ Q: Nto fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
! z' r+ P  Y% ^) \' c0 }+ J6 ]" fthat this demand cannot be sustained; and “supply-driven”
' K7 V/ L3 ~( vwhere builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
1 g+ D. }3 |5 K“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
0 o5 a* `! A: I$ _that is now being rapidly reined in.
. u& m+ m0 w4 r6 ~' A/ YWhile most markets won’t face U.S.-style overhangs,
" V! r, v# b% ]) R. N6 K% s( zthe construction of too many new homes over the boom
# l" X! ^9 P8 L+ S' jmeans a deepened slump. This overbuilding will likely weigh
% e( o, o0 z  y* a# aon markets over the next few years. Even as Canada recovers
from the cyclical downturn, house price growth will
/ a+ X$ z& N  G6 d2 i; Gremain choppy and new residential construction will be
) r0 Y+ p6 f2 }3 z" R8 [0 `* N. Udampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
% f. `; x7 d3 }+ w, D. xresidential construction will fall further to around
, L+ r- r) q( w, M' d125,000 starts over 2009 with a trough around 115,000 units
/ l: S# ~; N  Q9 b% din 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
province. 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
: S2 n! W4 ?& x, L( M, Mof residential construction.
To examine the degree of overbuilding, we employ a
' L0 m8 V8 b4 W! t" [' y$ `“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
units were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
) P9 Q) ^7 y$ u9 s& Pwhere housing demand will further contract under waning
) N! S3 H7 ~% L5 I- U5 u5 e8 Apopulation inflows. Saskatoon, Calgary and Edmonton are
1 [4 `7 k: X& ]7 m/ kalready witnessing surges in their unsold new homes at the
very time that the resale market has swung into strong
; X9 l9 _5 m. B, w* ~, ybuyers’ territory. Homebuilding in the Atlantic provinces
6 `  R6 k/ Y; q* W8 t, b$ @2 Phas been relatively balanced but, while not plagued by structural
' \) {  Q0 ~6 K9 Uweakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
$ c1 j8 p* e. r( d3 Istrange accumulation of unabsorbed multiples on l’Île de
! J7 u: U: C( O2 W& B6 X% A% qMontréal – 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
4 W: f1 F! ^! v& z: M% ?# Z# [" Pcyclical downturn, the degree of structural weakness appears
$ X/ b$ A  K# J# {3 X# i; f" climited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
  q7 i* }, J( ~  b2 n' R; ~7 ?construction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
, z* n( [, x6 {/ t+ A4 f2 L+ I% pcyclical factors would indicate, condo inventories could
( r$ r" M7 i! |: n) L/ }spike severely – particularly in Vancouver. However, while
& I! q  m: [% e8 u; d+ E  H4 qresidential 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,
. Y& s/ z1 u! H. S5 r1 u* Lwill alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
3 o3 X/ _. u+ e. A. q6 RGrant Bishop, Economist
0 P2 ?: K* O+ U. A9 b# U/ {9 d416-982-8063
1 U: b& T; G* e& k$ C/ O7 D1 mPascal Gauthier, Economist
416-944-5730

1 H+ V7 R2 N  `) O3 M* Whttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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