TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
# P" S; H0 v1 k; A" j# I( Tfrom 2002 to 2008, unsustainable price increases drove
8 A8 N  I& m& l. K) dunsustainable levels of building. Our view is that house
prices exceeded the value of housing that was justified by
9 }  `* H" x0 xfundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
0 ?7 P- U* E: o& E( C12%, an excess that was exaggerated in the past
three years.
) C: t6 J) o: E. j4 q! W7 c% {By “overpricing” we mean that prices detached from
* c6 d/ W5 Q. h) N3 Qtheir fundamentals, as witnessed by a steep erosion of
0 b' C. k! R/ X  [8 uaffordability. 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”
where homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
! N6 ~. h( J3 shomebuyers pushed homebuilding to an unsustainable pitch
+ h; `1 M2 l/ ]/ W+ ~$ b, O7 n0 g/ _that is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
. G9 h; A1 C  L- Q- U* o9 L5 O0 U1 ithe construction of too many new homes over the boom
  h5 p) A! W5 G9 jmeans a deepened slump. This overbuilding will likely weigh
) \' E# ^0 Z8 ^0 x9 t! Ron markets over the next few years. Even as Canada recovers
1 g; A/ J& f7 g, A+ z0 Kfrom the cyclical downturn, house price growth will
5 E4 p; h, @0 d- o5 U( S% j& o* qremain choppy and new residential construction will be
$ b5 t& l8 }) e, J" G' [4 Ldampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
' q. k& _. G+ g, W& ~6 p( nresidential construction will fall further to around
# I3 t. H4 U- q7 L. }8 [125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
& c! w  f! W: t- aTo 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
0 t; J( @( L, Z: @8 X' w& b+ Cvalues since house prices should track incomes over the
5 s4 R4 ~$ _, N2 s, v/ }" Q8 [long-run. Since homebuilders build to meet demand, we
7 ^4 V* z* m1 s1 B) Vregard housing prices and household formation as the drivers
( a& j1 k( W- a1 Dof residential construction.
To examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
0 q  |+ P2 |# v0 g7 ]8 C3 _, soptimally. We find that actual homebuilding exceeded this
7 H% J) o$ _) o% q2 u7 X; {fundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
4 X* e: ?9 w) Q! m- E: ARegionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
1 G* Y" e2 s( D% M. qpopulation 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
  w- m6 p0 ^1 Cbuyers’ territory. Homebuilding in the Atlantic provinces
  ?' z/ u2 p, l- ehas been relatively balanced but, while not plagued by structural
weakness, will be singed by the downturn nonetheless.
, G- t6 b, w6 LQuébec shows signs of strain – especially given the
* D6 P5 f) g+ c& p( ~! Cstrange accumulation of unabsorbed multiples on l’Île de
Montréal – 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
% ^5 p. J* e' e8 c! Jcyclical downturn, the degree of structural weakness appears
2 T1 h) b1 S" v6 z- nlimited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
4 i6 R- _- V+ ?& P. s. U% Q9 sconstruction mean that record numbers of condos will
0 x* K% {" g. o4 Zreach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
- g8 B, k9 u" z2 ~4 N6 |/ Z7 cspike severely – particularly in Vancouver. However, while
( [; L% a" G& |- ~" {5 A2 g3 Yresidential construction in B.C. will definitely droop, we
7 P" }9 Q* ?2 xanticipate that the West Coast will continue to benefit from
inter-provincial and international migration over the coming
years, which, along with improvements in affordability,
8 [+ _) ^6 |! x$ Qwill alleviate some of the pressure from overbuilding.
( H. o) b' r# Q0 d, ZOVERPRICED AND OVERBUILT: CANADIAN HOUSING
+ m* [0 O8 u3 Y  Z4 o$ d) `MARKET RETURNS TO FUNDAMENTALS
" I7 n4 l$ j' V- n5 qGrant Bishop, Economist
- V+ f4 t: \/ H! i7 |416-982-8063
Pascal Gauthier, Economist
416-944-5730

2 j( @( t, g5 a$ Ohttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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