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
% U% f( O; ?0 b% l6 S5 c; Junsustainable levels of building. Our view is that house
$ |% q; P& d$ U+ _* `# L! C" `/ Tprices exceeded the value of housing that was justified by
4 T" r$ I! f. m- D3 gfundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
& d& g% d& Z( P1 t3 C! o/ I" g. a12%, an excess that was exaggerated in the past
9 A5 s: @  r& B) t, Dthree years.
By “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
( @9 N7 O+ ^: X9 k* vaffordability. The current unwinding of house prices reflects
$ ?/ a! k% F) rboth a cyclical downturn and a return of house prices
1 W  Q3 `* A6 A. J: ^( Tto fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
  p& p0 k5 h, c8 c2 R# G4 n' }- Lthat this demand cannot be sustained; and “supply-driven”
* _9 E( {1 H) f+ X5 Swhere builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
  j. L& S2 O) Y0 n1 B) |“overbuilding” was mainly of the first type, where
9 v& d: e; E# n; rhomebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
0 d& C, z9 |9 L- n/ c$ bWhile most markets won’t face U.S.-style overhangs,
8 v- F9 D0 ^% e: @7 W" p8 Y, ~the construction of too many new homes over the boom
& r$ y  b, t( w+ o$ s! V1 y! d5 g1 Bmeans a deepened slump. This overbuilding will likely weigh
on markets over the next few years. Even as Canada recovers
; x! V6 Q9 ?4 b' k$ q. rfrom the cyclical downturn, house price growth will
% c; C3 g$ Y! H# t0 B. A# [3 tremain 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
1 w( K) V' l9 k/ Dresidential construction will fall further to around
/ M2 E9 y9 L8 I+ ^- }( B125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
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
province. Affordability is the key concept behind home
5 x2 \$ E# Y0 g2 q! V  Vvalues since house prices should track incomes over the
long-run. Since homebuilders build to meet demand, we
7 ]' G/ Y5 R  i4 L+ Q9 L6 x* Eregard housing prices and household formation as the drivers
3 I5 w6 n6 Q1 G: H/ X/ Z: pof residential construction.
' R  `) B8 Q& x) c+ U* ^3 _) H) xTo examine the degree of overbuilding, we employ a
0 d; f9 u2 `+ ]! Z$ Z% a“counter-factual,” asking what level of residential construction
: E% B7 }$ U% Awould have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
4 j* t. I( f* k+ I& Pfundamental-justified level by about 12%. Although new
* }" s3 _5 z; q  Q" Y5 V1 D/ _units were being absorbed, homebuyers simply bought too
, p4 e8 U3 ~: V8 a1 G4 Umany houses at prices that exceeded fundamentals.
# l$ `! g4 j' wRegionally, we see the greatest strains on the Prairies,
3 L' C- K0 D- [" pwhere housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
& }: T- z2 K+ t  U2 svery time that the resale market has swung into strong
buyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
weakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
strange 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
& _( }/ Z' p6 Y9 T+ ]1 Crates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
  `  ?, R0 s# O5 s- T  Ylimited – with the important exception of the Toronto
1 w+ S2 ?( D0 l  G5 s" ~$ U1 zcondo 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
. {, e! j! n$ }3 z" f& O9 u. Ncyclical factors would indicate, condo inventories could
5 j  A' f* V6 H$ |spike severely – particularly in Vancouver. However, while
residential construction in B.C. will definitely droop, we
/ }8 L6 G: n6 R4 W/ \/ ]anticipate that the West Coast will continue to benefit from
inter-provincial and international migration over the coming
  ]- L+ U. T/ r# ryears, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
; d# Q0 @" Y/ Y' h- h& {! F* C/ }MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
5 ~9 Y% h. k0 L; J: D, u* \416-982-8063
2 G7 {0 q6 [: s: q6 U5 XPascal Gauthier, Economist
416-944-5730

& N% O1 W0 {& Qhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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