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
+ b2 b; d) q0 ?( ~- yunsustainable levels of building. Our view is that house
' ?# P( c# L6 n4 d' D! t) K  Dprices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
/ x( v9 c% @+ W: M# w, ooverpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
/ n- Y1 k' L$ u* A' athree years.
By “overpricing” we mean that prices detached from
their 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
0 s) k6 [  M4 S! V! n' ato fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
7 K  k: m, e! X" E2 v& z% rwhere 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
  g, o# ]% `7 [8 i  S( O“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
, M1 @4 z, d8 d7 pthat is now being rapidly reined in.
3 H% H9 K8 |+ A( \% m) `While most markets won’t face U.S.-style overhangs,
$ R: z% d0 Q/ F3 [& S0 xthe construction of too many new homes over the boom
means a deepened slump. This overbuilding will likely weigh
: a# f8 p4 |  r  i5 x( K8 non markets over the next few years. Even as Canada recovers
from the cyclical downturn, house price growth will
0 E, s8 r5 i/ o9 Y6 Yremain 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 u  L: D3 Y& ]/ f- d4 q2 Eresidential construction will fall further to around
3 S% Y: @8 p2 E! e3 H125,000 starts over 2009 with a trough around 115,000 units
. [! m$ W7 e7 _  l6 x6 ]  J3 W7 oin the fourth quarter.
1 i6 l2 _! x6 v* g2 A# CTo quantify the degree of overpricing and overbuilding,
( ?- F! G; Y* K7 i. Y' c2 S! u! Qwe first develop an empirical model, based on long-run
' _4 n& D6 ~* A2 B& m) [fundamentals of house prices and housing starts in each
province. Affordability is the key concept behind home
values since house prices should track incomes over the
long-run. Since homebuilders build to meet demand, we
regard housing prices and household formation as the drivers
of residential construction.
To examine the degree of overbuilding, we employ a
# z4 g% d4 D+ [6 V“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
/ e* k3 l* T1 }2 Y' Joptimally. We find that actual homebuilding exceeded this
% M5 p5 G& T1 t( U  a, sfundamental-justified level by about 12%. Although new
units 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
) x/ E" X" D0 ^/ t/ L" n! @very time that the resale market has swung into strong
/ `4 p0 w! N$ B  Gbuyers’ 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
$ n! W, t: p! u& k, ^! cstrange accumulation of unabsorbed multiples on l’Île de
Montréal – but recent building has been relatively balanced,
$ W+ a' C6 o7 a2 `( Ugiven the province’s history of under-building and low ownership
( G* ^' n) x- Arates. While Ontario homebuilding will reel from a
8 T$ d4 k, \# W' ^( S+ xcyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
+ H9 g) d, N7 {construction mean that record numbers of condos will
% U3 f& d5 }6 Greach completion during 2009. If absorption rates fall, as
9 P$ p: B! H. I1 {. rcyclical factors would indicate, condo inventories could
; G/ V: v; o  Q1 nspike severely – particularly in Vancouver. However, while
+ A8 m+ i9 V7 jresidential construction in B.C. will definitely droop, we
$ \7 P( m; Z* A/ ~anticipate that the West Coast will continue to benefit from
* O9 ?  q7 V) [, c. R7 w, `7 r6 h. ^inter-provincial and international migration over the coming
5 H" }/ R( ^9 a% E1 S8 p, [0 ^years, which, along with improvements in affordability,
+ q) ^0 R6 d: u( z) Vwill alleviate some of the pressure from overbuilding.
) m# Y! @! n2 Q+ g: {; ]& K$ XOVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
5 W1 Y: {. y) D' g: j7 i- FGrant Bishop, Economist
. `1 @3 i" m4 e. y, s416-982-8063
Pascal Gauthier, Economist
416-944-5730

http://www.td.com/economics/special/gb0409_housing_exec.pdf

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