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
4 O- N: }6 ]! K: x7 Dfundamentals by approximately 9% nationwide. This
5 P7 ]$ R' ]0 E3 Aoverpricing compelled a level of residential construction
; a0 c* \# P9 E$ othat exceeded its fundamental-justified level by approximately
4 o% @/ M8 q( I- ?7 X% W$ {  p12%, an excess that was exaggerated in the past
, Z7 s- _, c" w8 q) Sthree years.
( U, J8 A4 O$ ]/ J6 h+ LBy “overpricing” we mean that prices detached from
& n. Q; Q( n1 K8 ytheir fundamentals, as witnessed by a steep erosion of
/ W4 d) |( |9 V$ G/ W  Xaffordability. The current unwinding of house prices reflects
both a cyclical downturn and a return of house prices
to fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
5 u. X- q# X/ n4 c, }; J4 Qwhere homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
) G. j% E3 {8 x2 y) x, h3 uwhere builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
$ B. n8 S8 V" Vhomebuyers pushed homebuilding to an unsustainable pitch
) [4 z6 c. ~: k& S% fthat is now being rapidly reined in.
4 d. p) {7 ~7 L! n" t% NWhile most markets won’t face U.S.-style overhangs,
! i1 t' a1 y: Q) S7 ^  K! [# I# Hthe construction of too many new homes over the boom
/ T, E, d" t) @' N4 |means a deepened slump. This overbuilding will likely weigh
4 Y) [7 n0 r9 d' ]& _+ B9 kon 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
to persist over 2009 to 2011. We anticipate that nationwide
residential construction will fall further to around
4 Z4 q, ~* J) k! Q  G8 {125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
To quantify the degree of overpricing and overbuilding,
2 J, `5 u7 H) X% E5 owe first develop an empirical model, based on long-run
* L& L" t4 l, ifundamentals of house prices and housing starts in each
- @7 w2 b" G- X, O# |3 [province. Affordability is the key concept behind home
" X$ }& n1 q% E6 B& Gvalues since house prices should track incomes over the
* k. B' T6 v0 K) u# ylong-run. Since homebuilders build to meet demand, we
! Y# l- {- ?! a2 Gregard housing prices and household formation as the drivers
# X! g& ]# w& V, V+ Rof residential construction.
& E  z; N9 X9 t+ l9 UTo examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
8 Y, C& `7 `- y1 K9 }optimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
' w: [) T( ], }2 T9 |( ?2 e# k5 A+ ]units were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
5 R& w- T0 _' f% mpopulation 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
2 C: R! {& ~/ z" n3 Z7 cbuyers’ territory. Homebuilding in the Atlantic provinces
2 b! \+ h5 {6 I% q7 D+ R, }has been relatively balanced but, while not plagued by structural
weakness, will be singed by the downturn nonetheless.
: |1 ?5 w; ?$ ?. d/ HQuébec shows signs of strain – especially given the
strange accumulation of unabsorbed multiples on l’Île de
5 D! M& }6 Y9 }5 q  h# NMontréal – but recent building has been relatively balanced,
! Q0 t, a3 \, A8 S' ^+ p- }given the province’s history of under-building and low ownership
0 K6 C5 u0 P  o. vrates. While Ontario homebuilding will reel from a
# \/ U' V6 \2 m2 J4 D& h9 ecyclical downturn, the degree of structural weakness appears
% i/ E- L5 ^5 f" ~limited – with the important exception of the Toronto
% v  g" Z' m( W0 Econdo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
construction mean that record numbers of condos will
7 D* x8 g6 z& G- i( O- h7 K$ L2 v5 areach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
residential construction in B.C. will definitely droop, we
: ^+ }3 Z2 x* O! }( e) S4 Manticipate that the West Coast will continue to benefit from
inter-provincial and international migration over the coming
years, which, along with improvements in affordability,
! M4 G3 n7 O. Z- k; T, A# kwill alleviate some of the pressure from overbuilding.
) l5 j; j" F  ^; C. XOVERPRICED AND OVERBUILT: CANADIAN HOUSING
1 B$ b4 h# P6 D% h- \7 AMARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
: S( o8 `4 y. U3 ?1 X% f416-982-8063
Pascal Gauthier, Economist
416-944-5730
3 `, R( S8 U+ x0 a
http://www.td.com/economics/special/gb0409_housing_exec.pdf

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