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
: k; d8 {& y8 R0 x/ Fprices exceeded the value of housing that was justified by
" H9 {  D8 p3 Xfundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
" r! ?' _6 ^4 r& J1 p' {. ^12%, an excess that was exaggerated in the past
! K- f' c8 C) i& d: _, H/ c7 y0 ?three years.
/ x5 k5 I, T% Q4 e& ]: D2 Y) UBy “overpricing” we mean that prices detached from
9 F' |! Y( z4 G/ F8 Qtheir fundamentals, as witnessed by a steep erosion of
2 E% c- n- a6 ?. i' }9 T5 qaffordability. The current unwinding of house prices reflects
both a cyclical downturn and a return of house prices
+ |, b( {* R8 t* U3 S$ Cto fundamentally justified levels.
6 H4 h9 |$ [7 {& g3 X/ wWe consider “overbuilding” of two forms: “demanddriven”
3 P+ P6 N+ q% ^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
0 u9 h0 ^4 k& l$ `“overbuilding” was mainly of the first type, where
& [2 ]6 |9 ?' |" v* H% x0 _homebuyers pushed homebuilding to an unsustainable pitch
3 L6 }  b6 ]( V# K7 s3 |4 qthat is now being rapidly reined in.
' Y( H7 A( C1 s0 E/ D# |While most markets won’t face U.S.-style overhangs,
, s1 u$ E' p) X8 s% m, Othe construction of too many new homes over the boom
# j, J5 s7 C5 ?means a deepened slump. This overbuilding will likely weigh
on 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
! {' @, t0 {' m( Hdampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
: U5 t& L1 P8 ito 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
in the fourth quarter.
6 y7 _& O0 u0 @& |/ @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
" m3 Y) m5 H$ D8 @1 jprovince. Affordability is the key concept behind home
$ T# T9 p0 Z6 M  I3 y2 V% Ovalues since house prices should track incomes over the
* t: \  X2 g0 n. S  llong-run. Since homebuilders build to meet demand, we
regard housing prices and household formation as the drivers
of residential construction.
) F4 Z8 x) k. m3 I( E: A$ yTo examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
  [' G) H" ~! roptimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
3 D! C' K! P5 b) K& C9 aunits 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
population 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
) t  s8 T" Q/ Dbuyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
: f4 _' `& A* ~weakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
' A" S4 {, Q! n1 N( x$ y7 N; Kstrange 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
! T4 E! l0 n. W6 rcyclical downturn, the degree of structural weakness appears
- r$ ^; }+ X( G! m- U9 L/ Glimited – with the important exception of the Toronto
3 x' c7 a2 j+ k8 \8 Fcondo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
construction mean that record numbers of condos will
% m, a# c' d3 @2 ]3 V' N6 vreach completion during 2009. If absorption rates fall, as
$ G! Y+ m7 h# O2 Icyclical factors would indicate, condo inventories could
; C% Z$ Z1 P$ F0 I/ Dspike severely – particularly in Vancouver. However, while
) I  P8 K7 s$ p, j; aresidential construction in B.C. will definitely droop, we
1 V1 u# X7 a! I8 g' T1 Z; xanticipate that the West Coast will continue to benefit from
7 p7 e" Q- I: o7 minter-provincial and international migration over the coming
years, which, along with improvements in affordability,
& B; k, R- [0 B! x$ X. cwill alleviate some of the pressure from overbuilding.
9 u" N1 R* _7 y1 b: r7 c# gOVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
0 {: R: e5 ^& J* R$ I* v* d: f# aPascal Gauthier, Economist
416-944-5730

5 }( M' m/ _. X5 h' b6 Xhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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