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
2 `. M/ X! P" |! ^# w! G% Iunsustainable levels of building. Our view is that house
prices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
8 b9 d6 b) f$ V2 C/ Koverpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
: w1 O  ~) q* Z$ z% Q4 ^) x0 V12%, an excess that was exaggerated in the past
. ?/ @( I9 h+ x2 _' v7 hthree years.
4 p3 C9 c. G# P, @1 X; D9 P+ U" jBy “overpricing” we mean that prices detached from
4 ~9 S3 g# v7 J$ d: a( E* D7 K( F- Vtheir fundamentals, as witnessed by a steep erosion of
  M, c+ z! W$ R7 e  p$ ~affordability. 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”
/ G. n/ m" k# Z4 r4 S- ]where homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
0 l3 J; b- w0 W1 O8 `  swhere 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
9 r+ L* A3 |, n- |1 k5 d" u/ Cthat 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
means a deepened slump. This overbuilding will likely weigh
1 x+ o- ?2 ?7 ?on markets over the next few years. Even as Canada recovers
/ h& r& M  S4 tfrom the cyclical downturn, house price growth will
remain choppy and new residential construction will be
7 a8 P* P+ V' G( Adampened, owing to this structural weakness. Construction
4 A+ O, W, U/ }; cis now undershooting fundamentals and we expect this
  ~: w% e/ c! z: u1 Mto persist over 2009 to 2011. We anticipate that nationwide
residential construction will fall further to around
2 c9 f3 ^: L& c1 f, N: @$ t0 r125,000 starts over 2009 with a trough around 115,000 units
3 {& X5 }: t+ D. Nin the fourth quarter.
To quantify the degree of overpricing and overbuilding,
+ B1 k; Y" K& G5 T9 T6 ywe 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
  v1 w% g  `2 F% J3 Kvalues 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.
2 R; h0 X# g) U- d5 NTo examine the degree of overbuilding, we employ a
8 d0 M; F( M7 W0 H“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
8 Q- S$ l, X' c' ]8 i) H6 \optimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
: h) m7 L$ E: C& K$ z) ]units were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
% C; v- E9 y: ~1 Q) RRegionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
' ?& F" @9 Y4 r, X* npopulation inflows. Saskatoon, Calgary and Edmonton are
1 V5 I% f5 N- S3 _8 ^already witnessing surges in their unsold new homes at the
very time that the resale market has swung into strong
' l& U) @. z- @, ]buyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
1 H! m  ?4 k; ]0 k5 b, mweakness, will be singed by the downturn nonetheless.
2 U8 W4 O' ~# {) [1 I& x& ~Québec shows signs of strain – especially given the
  ~0 m. z  r! ~5 W, ostrange accumulation of unabsorbed multiples on l’Île de
2 j: g  ~7 {. O, l  S3 h5 P: K% ~Montréal – but recent building has been relatively balanced,
# i+ j* O2 m& k7 l* T: R0 @given the province’s history of under-building and low ownership
rates. While Ontario homebuilding will reel from a
' m6 o9 T8 M7 K9 ]4 ucyclical downturn, the degree of structural weakness appears
: q0 Q: }" c$ e& u# @: ?. alimited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
3 j5 x1 N( x/ X! K7 ]" O) oconstruction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
9 ]* `7 g& ~% R8 icyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
residential construction in B.C. will definitely droop, we
; W4 l$ t/ x, [% o, n2 ?anticipate that the West Coast will continue to benefit from
/ d  c5 P4 M5 G" e  Y, T/ Zinter-provincial and international migration over the coming
years, which, along with improvements in affordability,
- f& q  b% p" V8 E: S6 bwill alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
, F! h  c$ [6 u- A" EMARKET RETURNS TO FUNDAMENTALS
  e8 Q9 C6 P$ V4 GGrant Bishop, Economist
416-982-8063
. X5 k# t9 R6 s( dPascal Gauthier, Economist
, V; a1 w, q6 a- D* j416-944-5730

" P) q  r+ |& }5 P5 Ghttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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