TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
$ b+ N. H9 ~4 d+ |from 2002 to 2008, unsustainable price increases drove
unsustainable levels of building. Our view is that house
9 ]. `, D2 h8 }& p  m- u# tprices exceeded the value of housing that was justified by
9 {+ H1 i( S4 x7 @( cfundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
2 e1 Z! Y( X+ h7 H& w12%, an excess that was exaggerated in the past
- T, |& n) t, y1 m1 P6 S0 c9 dthree years.
6 {$ }1 Y& ~" |# ]! E* B, _/ QBy “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
* ^; A3 j+ J! b4 B$ r+ dboth a cyclical downturn and a return of house prices
8 q- \$ @* C/ K/ k5 Qto fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
- e! X* l  T# |  |4 P% @( _where homebuyers buy up too many houses and
" I  [, q# T5 o$ G+ hthat this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
7 T( b$ r/ @" O7 B. R, }there is evidence of both types, we contend that Canada’s
) F9 f( V1 g2 V9 l3 c“overbuilding” was mainly of the first type, where
" n8 x3 g7 {7 I6 @$ G; uhomebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
( b8 [* n  g. J3 \3 @& Wthe construction of too many new homes over the boom
means a deepened slump. This overbuilding will likely weigh
on markets over the next few years. Even as Canada recovers
from the cyclical downturn, house price growth will
2 s3 J. B" j: _; A1 ]8 {) eremain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
% C- ?# P4 r5 ~- I! M& His now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
& f) y6 _! c, E  O! A. Q3 bresidential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
) O) A: t  Q' U+ V$ sTo 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
7 P2 m" ]0 U3 I4 R+ e/ yprovince. Affordability is the key concept behind home
values since house prices should track incomes over the
. D; s' G8 S4 K# ]$ i5 s: Ulong-run. Since homebuilders build to meet demand, we
& w$ {# |& C9 U5 |& g  t. _regard housing prices and household formation as the drivers
+ G( N" s; h! _! Vof residential construction.
To examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
7 J2 c. ?1 r+ H% z  y% Hwould 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.
5 f  i3 s; g6 e/ URegionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
( |, b" Q  y7 x1 t( A! G0 K# k# talready witnessing surges in their unsold new homes at the
very time that the resale market has swung into strong
- ?' v0 H: o+ e/ f4 s, w) b$ T4 \buyers’ territory. Homebuilding in the Atlantic provinces
% I8 _; {0 O3 M; I/ J% x! ihas been relatively balanced but, while not plagued by structural
! i8 s9 }- u8 F! l( i% i" Hweakness, will be singed by the downturn nonetheless.
( f8 ?/ a5 E/ G. U' _& C+ L  g' ^Québec shows signs of strain – especially given the
strange accumulation of unabsorbed multiples on l’Île de
Montréal – but recent building has been relatively balanced,
given the province’s history of under-building and low ownership
# b8 L- }" K8 jrates. While Ontario homebuilding will reel from a
  `( J+ {% y% c1 K0 c" ~% Xcyclical downturn, the degree of structural weakness appears
6 F2 M# w  {+ G, R& t) [limited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
  ~( P% F8 S0 x' ]; g- }high levels of apartment-style units presently under
construction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
( M) F8 v+ K' W  S) bspike severely – particularly in Vancouver. However, while
' y- m- O: v& g# m" Gresidential construction in B.C. will definitely droop, we
: W+ @) A# S! @) yanticipate that the West Coast will continue to benefit from
6 |( N& P  N: U! e) l, F8 Uinter-provincial and international migration over the coming
years, which, along with improvements in affordability,
* C5 ~, j( h( O  Xwill alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
Pascal Gauthier, Economist
+ m1 n, K! A, L5 o. o416-944-5730

" o) ~( ?: F1 o/ v2 q& {http://www.td.com/economics/special/gb0409_housing_exec.pdf

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