TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
6 q1 k4 x# z3 o! a' ?  N% D& rfrom 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
/ }- O; v9 K  j) cfundamentals by approximately 9% nationwide. This
% M  J7 y7 |! s2 G( O& t$ U6 ~6 Foverpricing compelled a level of residential construction
* l! K, t( z5 i- o& r: [that 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
( y0 K$ T7 r0 ~2 mtheir fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
; _2 `( J+ Z  Q1 lboth a cyclical downturn and a return of house prices
8 Y# M# l" f+ qto fundamentally justified levels.
5 }5 Q# e2 i2 ]+ gWe consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
  H, f8 V6 v2 x+ j/ A+ g+ K0 m6 Rthat this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
6 l+ E" c0 u& E0 d) Hthere is evidence of both types, we contend that Canada’s
; o4 T+ W  h* Y  s! {“overbuilding” was mainly of the first type, where
( V7 S9 s( {; t! m, W  mhomebuyers pushed homebuilding to an unsustainable pitch
. O0 }3 I, f1 y: Cthat is now being rapidly reined in.
' X3 X! |$ w3 O7 K3 }! [While most markets won’t face U.S.-style overhangs,
the construction of too many new homes over the boom
$ c$ s1 k" j$ @5 p, V: Fmeans a deepened slump. This overbuilding will likely weigh
; m. {2 Q3 q5 f8 ~% @on markets over the next few years. Even as Canada recovers
+ ^- j, Z1 i. X  l& |) g* G& ufrom the cyclical downturn, house price growth will
6 i/ c3 _- U7 cremain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
( c7 N6 b4 d! v3 f% Lis now undershooting fundamentals and we expect this
. e; |  U5 T: c+ J+ |to persist over 2009 to 2011. We anticipate that nationwide
( u9 u- G1 ?/ s' {7 D/ fresidential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
* n" S* _) B/ o8 cTo quantify the degree of overpricing and overbuilding,
we first develop an empirical model, based on long-run
( U9 {. N7 s2 v, ?; ^. zfundamentals of house prices and housing starts in each
9 M! R) }0 h' q; c9 O6 @province. Affordability is the key concept behind home
# W; j+ v8 R9 ]  C7 [$ `values since house prices should track incomes over the
, S( R9 S* o0 U( ?: j% p' l' d$ }6 ], P% rlong-run. Since homebuilders build to meet demand, we
regard housing prices and household formation as the drivers
of residential construction.
' K" {  J3 [: q4 @- [2 jTo examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
; ^% P: k( }' w( b( A* Y6 _would have occurred if housing had been priced
: K" x  b. ]7 V1 c8 f8 V, hoptimally. We find that actual homebuilding exceeded this
/ a5 R8 g( U5 @: W) Xfundamental-justified level by about 12%. Although new
* g5 F% d) G3 [. J  a0 sunits 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
* q; m2 f$ [( e) o2 uvery time that the resale market has swung into strong
& z& Y* A! m9 t3 f+ ~buyers’ 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
7 \/ W" n% \2 |  d$ R* lstrange accumulation of unabsorbed multiples on l’Île de
2 R4 o1 q1 M( I: e5 _5 |% EMontréal – but recent building has been relatively balanced,
, g  _9 K- E3 ^1 v) O% Q6 ^given the province’s history of under-building and low ownership
rates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
* o* r$ u5 Z1 K, tlimited – with the important exception of the Toronto
$ g. p: D3 g! D$ p. T. m) xcondo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
+ A8 e4 G5 T5 U3 econstruction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
& C/ d7 z8 P; jresidential construction in B.C. will definitely droop, we
9 |" _7 A% _8 j/ E! v; \1 E: yanticipate 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.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
. y- B, {( S8 H6 b3 `7 j" mGrant Bishop, Economist
+ q3 N/ `: C) `416-982-8063
7 G' U' W- @/ w( B( n$ a  n& vPascal Gauthier, Economist
* M5 G  O# v  l) ?* X# S416-944-5730
0 v! K( o  v$ u" H$ E5 t; \
! \( n9 f9 {" w0 b/ y/ rhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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