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
prices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
" W. v' S1 Q* w1 p( H1 E6 ]! U4 Ythat exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
three years.
By “overpricing” we mean that prices detached from
- w" E* A8 P4 l' M0 Z! P9 ^9 F$ Ytheir fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
8 n7 @9 s' X- I" j" i* j& }both a cyclical downturn and a return of house prices
to fundamentally justified levels.
, a$ m  o3 @! B9 \6 c5 DWe consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
6 i" K7 `2 O  o! D" T1 \that this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
$ t% T& F* K5 @/ Fthere is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
& r# v$ l* h1 a8 i0 q# H7 Mthat is now being rapidly reined in.
2 V. w- c' L# m  A5 \& ^0 |, z- gWhile most markets won’t face U.S.-style overhangs,
the construction of too many new homes over the boom
means a deepened slump. This overbuilding will likely weigh
7 t9 ?, }& B1 K1 K* \on markets over the next few years. Even as Canada recovers
( U7 _7 t& v$ S  Bfrom the cyclical downturn, house price growth will
) [0 P+ T& l, s' C6 Bremain choppy and new residential construction will be
7 l; i0 W+ K: ?, G  z# {& [( |, i& q0 zdampened, owing to this structural weakness. Construction
; f+ ^5 b( `2 N% `1 lis now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
* ~- T" d) q& Y( ^/ ^residential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
6 J3 v6 U) z# G, f. rin 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
6 z- t1 e$ y  J$ d$ O0 bvalues since house prices should track incomes over the
long-run. Since homebuilders build to meet demand, we
# Q& B: f: `) y3 U# Jregard housing prices and household formation as the drivers
5 l* s' x/ b( w& k/ y( e4 t& N' Sof residential construction.
+ {, u+ w0 i! ]To examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
- {7 z, X. A$ Y% {+ @would have occurred if housing had been priced
+ X8 \0 V& [! A) m: i7 s4 D% Uoptimally. We find that actual homebuilding exceeded this
/ J. C; P5 C, v8 a* Z2 efundamental-justified level by about 12%. Although new
  Y' ]: l6 D- g3 Gunits 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
! b. ]( L9 r4 ~  Fvery time that the resale market has swung into strong
buyers’ territory. Homebuilding in the Atlantic provinces
8 y* e0 X7 p( z4 p/ h/ s! Ihas 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
- B& z3 G) E% C4 BMontréal – but recent building has been relatively balanced,
given the province’s history of under-building and low ownership
  ^5 s& H+ c1 [4 i  H% t! irates. While Ontario homebuilding will reel from a
! [' E6 M, d% jcyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
6 y6 e1 H  |: ]9 f1 }6 Zcondo market. Both in Toronto and Vancouver, historically
% R" ~+ M9 T) V+ M$ G7 l' v: L% Yhigh levels of apartment-style units presently under
construction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
1 G& f# H) p2 j1 [; M5 L& K, _cyclical factors would indicate, condo inventories could
& Q0 M5 m) h! s' a1 ~3 K1 N+ C! X8 Mspike 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
7 p, `) Z8 T+ w& s- d! F4 Xyears, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
; C9 L2 n) r# y: Q7 dGrant Bishop, Economist
416-982-8063
Pascal Gauthier, Economist
416-944-5730
2 X7 l. T+ R7 W
! N, c0 t* k1 M; ~http://www.td.com/economics/special/gb0409_housing_exec.pdf

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