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
6 _  H3 |9 l5 d0 R8 Q+ T, iprices exceeded the value of housing that was justified by
1 T/ Y) E; f5 W) _fundamentals by approximately 9% nationwide. This
( n8 P( x7 }- U6 m. q" soverpricing compelled a level of residential construction
% t* l( l" r# G, T4 f- D5 Mthat exceeded its fundamental-justified level by approximately
% f) @. K: l2 A; t3 d+ ~) {; r8 K12%, an excess that was exaggerated in the past
* b6 ^7 z  m( \$ c+ A- Othree years.
By “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
( |1 q0 w) [0 p7 f8 baffordability. The current unwinding of house prices reflects
) N; S7 B( H. Y9 e6 C! L( Yboth 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”
* s- z! Y" o% o2 ]5 Twhere builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
( `  \; I/ \: F; h- d  u, G“overbuilding” was mainly of the first type, where
; M6 A  @% d: E/ E; Vhomebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
8 }; S" T; D' _; qWhile most markets won’t face U.S.-style overhangs,
2 R0 W& t9 a2 i  i: Z4 zthe construction of too many new homes over the boom
means a deepened slump. This overbuilding will likely weigh
on markets over the next few years. Even as Canada recovers
' G9 ~& W& r; q- r+ X" `from the cyclical downturn, house price growth will
remain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
) r# V5 T" ^1 h8 nis now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
residential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
2 E7 W( l5 T6 l1 [in the fourth quarter.
% u/ ?0 _3 ~' QTo 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
: |) D# P1 G: X) j* k: Z0 l. b$ jvalues since house prices should track incomes over the
+ \5 j- R( k# K& H1 k/ \0 M  W9 Elong-run. Since homebuilders build to meet demand, we
0 \4 d0 x. O) P  ~& jregard housing prices and household formation as the drivers
of residential construction.
1 V& N7 S6 @4 F7 S0 b1 jTo examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
; [# S2 H; q# {* Toptimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
! e# `9 F. M: |! l4 N; r" Tmany houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
& Q3 ?: p! \8 b% Iwhere housing demand will further contract under waning
, ^+ G4 N- q: Zpopulation 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
9 l& L$ |0 y+ abuyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
2 I1 J8 ?4 H( U7 Q. G7 B5 @& u5 s" lweakness, will be singed by the downturn nonetheless.
" z! K/ }& k- f& W3 F: v1 D( oQuébec shows signs of strain – especially given the
: O+ u  H) ~/ {6 |7 Gstrange accumulation of unabsorbed multiples on l’Île de
Montréal – but recent building has been relatively balanced,
# Q6 e9 y8 Q3 d2 k/ G4 c5 Cgiven the province’s history of under-building and low ownership
rates. While Ontario homebuilding will reel from a
. _+ [0 A3 X" q$ n5 y) Y, Q5 acyclical downturn, the degree of structural weakness appears
3 ~% g& C' d( A% a9 ^. c; Q0 Plimited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
construction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
% R0 P6 T+ I! T7 d# R: F6 r5 L/ Presidential construction in B.C. will definitely droop, we
9 l# W% P$ N  `# m9 Fanticipate that the West Coast will continue to benefit from
$ e  I1 M: a1 yinter-provincial and international migration over the coming
years, which, along with improvements in affordability,
0 T* s' E, ^- |) ^5 V% u' t2 t! fwill alleviate some of the pressure from overbuilding.
6 _, v# w" _7 _- [OVERPRICED AND OVERBUILT: CANADIAN HOUSING
7 O2 d' g8 }* r" b4 `MARKET RETURNS TO FUNDAMENTALS
& ~! S7 }5 L+ d% ]. qGrant Bishop, Economist
416-982-8063
, t( J& V3 i6 `' [% ^+ n6 |Pascal Gauthier, Economist
416-944-5730

7 }: v. n, J6 Q4 F) A4 Zhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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