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
+ p9 @  @. ?) I. X% Aprices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
: M( v! q3 N+ Y: K$ E7 s( a9 Aoverpricing compelled a level of residential construction
5 E* }" H) B( m5 {1 {. c6 s  s8 T4 Dthat exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
( X! C6 t$ W# Y7 F4 x% Rthree years.
$ x9 `8 D, _, ]  \+ c, e; [8 jBy “overpricing” we mean that prices detached from
% n  O8 k  D9 D! e3 t$ I0 T/ c0 xtheir fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
both a cyclical downturn and a return of house prices
- B/ v! @" ~# U4 T" Hto fundamentally justified levels.
# \- [7 N3 i) `8 D2 YWe consider “overbuilding” of two forms: “demanddriven”
+ ^# o, a3 W# |/ kwhere homebuyers buy up too many houses and
, I  w' S# z' y6 J. F1 q: S6 }0 f2 Lthat this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
$ v5 T: a' r6 w0 V: G" V4 i+ i; M5 u" ethere is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
4 l, }+ R% m+ L6 v# Qhomebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
7 ?  G, C4 L7 J5 b- v- Z* jWhile most markets won’t face U.S.-style overhangs,
the construction of too many new homes over the boom
2 k7 x" |6 j* j! }* A0 P4 ?2 Ymeans a deepened slump. This overbuilding will likely weigh
on markets over the next few years. Even as Canada recovers
4 V4 \; Q& m7 ~. t1 gfrom the cyclical downturn, house price growth will
remain choppy and new residential construction will be
! @9 b: `5 g! d- o1 Kdampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
( O" I& `* ~& D! D0 Q( Rto persist over 2009 to 2011. We anticipate that nationwide
$ G# v- j) v1 }- k1 Kresidential construction will fall further to around
9 f$ r, h6 P( b7 o+ i125,000 starts over 2009 with a trough around 115,000 units
; D6 u' R2 |: m( \6 ^in the fourth quarter.
To quantify the degree of overpricing and overbuilding,
3 y  x1 K- b" p% ~, t$ h& ?we first develop an empirical model, based on long-run
fundamentals of house prices and housing starts in each
* T( a' _# h% }3 i3 Aprovince. Affordability is the key concept behind home
values since house prices should track incomes over the
# F  Z  c# }1 C1 h% K( H1 Hlong-run. Since homebuilders build to meet demand, we
6 z( ^( Q6 ?8 K' e/ \4 hregard housing prices and household formation as the drivers
of residential construction.
; z6 ~- p+ e/ vTo examine the degree of overbuilding, we employ a
& u0 ~0 b3 f, }5 N“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
. O) e' f  B! ?$ u, boptimally. We find that actual homebuilding exceeded this
7 P: }) r$ L+ jfundamental-justified level by about 12%. Although new
7 T% r. e; S; H0 Kunits were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
" _  W3 Q" Z+ V# q; t1 Z8 uwhere housing demand will further contract under waning
' M+ p7 b2 q  F- ^7 J$ wpopulation inflows. Saskatoon, Calgary and Edmonton are
. M( P+ S6 P( talready witnessing surges in their unsold new homes at the
very 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.
$ c& ~$ G) G9 Z: M. N% ?( YQuébec shows signs of strain – especially given the
strange accumulation of unabsorbed multiples on l’Île de
' ]8 A( Y% @9 x& n. t% {% q' |Montréal – but recent building has been relatively balanced,
given the province’s history of under-building and low ownership
, y7 K* b  Q3 W/ @rates. While Ontario homebuilding will reel from a
8 j9 V# }8 a! B1 ?  H. ]cyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
6 |' f* F$ |; |( l, \condo market. Both in Toronto and Vancouver, historically
- T4 z5 U: {- H/ bhigh levels of apartment-style units presently under
construction mean that record numbers of condos will
1 o- {, S3 W2 b* Zreach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
% ^! y  P. v7 Fspike severely – particularly in Vancouver. However, while
' P# [- I) t+ y3 h7 p7 X" Vresidential construction in B.C. will definitely droop, we
) D! b8 C1 |" k( j) H8 K' y1 Zanticipate that the West Coast will continue to benefit from
inter-provincial and international migration over the coming
/ J; J! x. R# r; s% ?* f! B2 jyears, which, along with improvements in affordability,
$ W# l( T' ]% ~( M' W* [/ T; Nwill alleviate some of the pressure from overbuilding.
# L- X! @! U& f! nOVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
% R5 N3 M$ q+ G" q, h( ^Grant Bishop, Economist
416-982-8063
7 a& q, d0 ?* u" y, FPascal Gauthier, Economist
6 Z' _6 R8 b+ ~; @416-944-5730
9 C; O6 ~6 D, p, }1 i3 |1 I3 \2 D
* k0 `1 j% A' i# Y- mhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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