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
) a+ l" j6 v2 R" I# e* |9 r' j5 r4 Qthat exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
7 P( R' t) q! W2 v7 uthree years.
By “overpricing” we mean that prices detached from
their 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
4 ^/ w- q; @. R6 V5 Eto fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
5 R" d! d4 @5 ]: ewhere homebuyers buy up too many houses and
4 ]; |% V# K8 a! ythat this demand cannot be sustained; and “supply-driven”
" o/ \  ^  _3 v1 `& g; c8 h; k. x$ cwhere builders accumulate excessive inventories. Although
! V1 X9 V) S: U3 mthere is evidence of both types, we contend that Canada’s
: S4 N0 N% ], K5 b" D8 s“overbuilding” was mainly of the first type, where
0 F- ~* F0 C( y4 R+ a; e& Uhomebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
+ X  v+ @  R$ s" G8 r# Ethe construction of too many new homes over the boom
means a deepened slump. This overbuilding will likely weigh
$ z1 Z0 l" w5 v- b# Con markets over the next few years. Even as Canada recovers
from the cyclical downturn, house price growth will
" z! c+ w3 J4 Y6 m9 z! Y  \, L; oremain choppy and new residential construction will be
4 |8 b( \- x5 ]3 z0 `dampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
residential construction will fall further to around
/ ]9 T5 T/ i+ x/ E8 f/ }# T- Z125,000 starts over 2009 with a trough around 115,000 units
in 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
3 w& ^. n0 N* eprovince. Affordability is the key concept behind home
, `+ f" E2 G9 g9 i- m) f! Svalues since house prices should track incomes over the
long-run. Since homebuilders build to meet demand, we
0 ~& F# L' D* H3 \6 E/ s( ?. H) @regard housing prices and household formation as the drivers
of residential construction.
To examine the degree of overbuilding, we employ a
6 s# t* q3 N! I# F3 u/ s“counter-factual,” asking what level of residential construction
2 R; v- P( h& R9 V4 g$ J" H+ x" Ywould have occurred if housing had been priced
: E+ h3 f6 y5 |# i6 Yoptimally. We find that actual homebuilding exceeded this
  m3 \; n/ F, Yfundamental-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,
1 y5 z: x: ^8 u  ?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
very time that the resale market has swung into strong
# K) _- y0 g% |! Wbuyers’ 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
* J5 q+ Y9 Y9 }7 Nstrange accumulation of unabsorbed multiples on l’Île de
0 |  R; e: e* S; H% F; m* M# BMontréal – but recent building has been relatively balanced,
given the province’s history of under-building and low ownership
& G& K% c: I2 \6 srates. While Ontario homebuilding will reel from a
$ h0 q( X' r1 y5 j: B" E) w! I9 ?! ecyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
* ?0 n+ S2 U3 ccondo market. Both in Toronto and Vancouver, historically
  }' p) z& `9 G% C! J( _0 l$ Ahigh levels of apartment-style units presently under
construction mean that record numbers of condos will
' d0 ?+ x1 M+ m; P9 F% _! nreach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
7 h7 y$ a( ^" \' ^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,
7 a( N7 H: W# l" r  vwill 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
$ ]1 X# }5 H- M7 {5 }7 u416-944-5730

http://www.td.com/economics/special/gb0409_housing_exec.pdf

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