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
5 t4 Y0 o6 M9 U4 cunsustainable levels of building. Our view is that house
prices exceeded the value of housing that was justified by
8 F7 l/ A/ {! b3 y5 L; Dfundamentals by approximately 9% nationwide. This
+ j. N, _8 w* o; B& k1 `overpricing compelled a level of residential construction
9 |4 s; v. q! I8 o, M" B, Kthat exceeded its fundamental-justified level by approximately
! d2 O2 I7 ^  R5 {9 D4 ?% i& _: ]12%, an excess that was exaggerated in the past
three years.
' p2 q  j  c9 ?% F: QBy “overpricing” we mean that prices detached from
3 E, `$ ~, v3 @) ~9 ]! M6 _3 Qtheir 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
* E8 C; _1 v- e$ B: uto fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
+ g# O0 u6 W+ y1 C% ^% d& H4 U6 Pwhere 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
% l$ R) Q+ b; T8 }- |5 |“overbuilding” was mainly of the first type, where
' T% N6 f! e* F" f) lhomebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
* j; N6 l. W& G* PWhile most markets won’t face U.S.-style overhangs,
' M; J5 }: [, I% n5 s$ w: D, Ethe construction of too many new homes over the boom
- k8 [$ Z$ u7 a. ]6 v  Umeans a deepened slump. This overbuilding will likely weigh
% p. Z7 K9 K8 V0 mon markets over the next few years. Even as Canada recovers
from the cyclical downturn, house price growth will
. y- U3 u9 W9 o6 sremain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
# e( o) ~0 ^" o6 I+ ^( T: ato persist over 2009 to 2011. We anticipate that nationwide
residential construction will fall further to around
6 O2 A9 Y1 G$ V7 G5 b125,000 starts over 2009 with a trough around 115,000 units
  U9 S: q5 E; q1 Xin 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
2 c  Y6 g. C; F% V6 m: z8 ~province. Affordability is the key concept behind home
values since house prices should track incomes over the
0 r( S+ d2 D7 a4 x2 I9 plong-run. Since homebuilders build to meet demand, we
7 q" _! U/ }7 o( O! R& J# Z0 Eregard housing prices and household formation as the drivers
of residential construction.
; g& _! ~+ B7 }  [1 i4 HTo examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
9 y/ O; j- s$ l- v4 ]optimally. We find that actual homebuilding exceeded this
fundamental-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
& C; R* l. o5 d1 _population inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
% \: b5 b4 S- h+ t( N: m# xvery time that the resale market has swung into strong
4 D' a7 l% F9 U9 Xbuyers’ territory. Homebuilding in the Atlantic provinces
9 B0 z' o# r* N# Q! ]has been relatively balanced but, while not plagued by structural
6 v% S3 D6 A$ Z2 s5 fweakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
strange accumulation of unabsorbed multiples on l’Île de
2 M" k9 K7 s; H5 o/ z* \' VMontréal – 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
$ H' A1 H' C6 `6 V  acyclical downturn, the degree of structural weakness appears
9 p  `+ ^! _" ylimited – with the important exception of the Toronto
+ [2 }) ?3 a. Q+ g0 tcondo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
$ h  w$ T0 v! `/ s& v6 s* h, nconstruction mean that record numbers of condos will
$ M- @& L4 P. h. m2 V, G/ v; B( mreach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
8 `$ Y7 l7 ?4 d, i8 bspike severely – particularly in Vancouver. However, while
residential construction in B.C. will definitely droop, we
anticipate that the West Coast will continue to benefit from
inter-provincial and international migration over the coming
years, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
7 Q+ W0 J8 `" D- \$ Q4 EOVERPRICED AND OVERBUILT: CANADIAN HOUSING
& a( j  S( h& W5 iMARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
4 w; ^% M' ~. H% E2 {2 K  q416-982-8063
Pascal Gauthier, Economist
416-944-5730

; w! @- o7 h3 @7 `3 U7 f7 i+ n+ @http://www.td.com/economics/special/gb0409_housing_exec.pdf

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