TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
6 h+ F/ u6 _9 Jfrom 2002 to 2008, unsustainable price increases drove
: V% B$ x  U! V) ^% Aunsustainable levels of building. Our view is that house
6 M; @! L- d1 V, M+ U, f, iprices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
, O! a$ `% w7 Q5 a% }% d8 Uoverpricing compelled a level of residential construction
) d% d' O# v2 e( [  m* cthat exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
# `9 n; ^- y, u( }( a% Sthree years.
* S" K2 K* y$ }" d) R! `By “overpricing” we mean that prices detached from
, Z" t/ t! U! c- vtheir fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
/ ]) e/ p! {1 e  X1 K2 F+ `/ t4 P* Mboth a cyclical downturn and a return of house prices
to fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
7 K% b/ H: ^8 W( |2 kwhere homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
* F! q  i( B$ L$ |& B' Iwhere builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
, }0 C' i' s4 p( b5 N1 u' i“overbuilding” was mainly of the first type, where
5 p5 T. c( d! R; t* ghomebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
While 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
! f( _8 Z# V& l( [- i. con markets over the next few years. Even as Canada recovers
! J- ~# G& @" pfrom the cyclical downturn, house price growth will
0 h1 c4 K2 E* L4 V7 K, rremain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
- M! @9 `- Q  B* Y7 p1 i( [& ]  ois now undershooting fundamentals and we expect this
* Q, i/ T7 w! t, v( h3 S7 l$ i& Lto persist over 2009 to 2011. We anticipate that nationwide
residential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
0 l; P( k1 T0 s) L7 Y% L9 oin the fourth quarter.
3 D/ `& J) S% U9 bTo 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
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.
- X8 d/ Y* Y3 ?/ p( I9 G/ w& i/ T! T/ @/ mTo examine the degree of overbuilding, we employ a
. |$ O- K; q; V/ W/ a9 z* H0 ]# A“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
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,
+ C6 q- F/ J  p, P- F2 }7 d" z2 }where housing demand will further contract under waning
  Q- x) C+ e5 X- @0 [& P/ bpopulation inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
9 G& a/ n# ~) k& \; o% h+ ]3 mvery time that the resale market has swung into strong
buyers’ territory. Homebuilding in the Atlantic provinces
. V8 z2 O: d7 D7 v6 A/ qhas been relatively balanced but, while not plagued by structural
& D. s: M, m% _+ @2 p! L7 }weakness, will be singed by the downturn nonetheless.
' U& U$ x  S9 o  U  l1 MQuébec shows signs of strain – especially given the
strange accumulation of unabsorbed multiples on l’Île de
2 N  f3 v0 p  G( DMontréal – but recent building has been relatively balanced,
given the province’s history of under-building and low ownership
, I- s0 A6 C* v5 S' @6 W8 h! Arates. While Ontario homebuilding will reel from a
. n5 Y6 k' x5 ~( }2 u. _cyclical downturn, the degree of structural weakness appears
: ^0 ~+ @" i/ s& [+ nlimited – with the important exception of the Toronto
3 f, G. o- ]8 {2 acondo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
  M1 N* P& [- Mconstruction mean that record numbers of condos will
! B2 i2 t7 Y- F& J  d4 Q& Ireach completion during 2009. If absorption rates fall, as
; D4 D) ?& c2 e, O0 Lcyclical factors would indicate, condo inventories could
- v! a1 N7 Q9 A8 zspike severely – particularly in Vancouver. However, while
3 I) T" _  ~. tresidential construction in B.C. will definitely droop, we
anticipate that the West Coast will continue to benefit from
  D0 h* r& ^2 H% _inter-provincial and international migration over the coming
years, which, along with improvements in affordability,
5 C( l" R0 F3 {will alleviate some of the pressure from overbuilding.
6 n4 n8 P8 ]- D+ jOVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
0 {8 w6 Y* V+ V: [7 AGrant Bishop, Economist
416-982-8063
& u. I+ L, Q- _! E9 RPascal Gauthier, Economist
416-944-5730
1 g- o" r4 F  n$ m
8 b' A" ]- M8 F) l) y# i! Ghttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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