TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
% J) m# W) a# {' _+ h$ _from 2002 to 2008, unsustainable price increases drove
" B& I5 l+ w6 @unsustainable levels of building. Our view is that house
6 P( W+ P" g; q# B# Wprices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
. I$ w$ G4 q& `/ u; uthat exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
three years.
+ k+ L4 _) z+ ?0 \By “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
. D: m" x4 f( p1 S7 N% p. uaffordability. The current unwinding of house prices reflects
both a cyclical downturn and a return of house prices
to fundamentally justified levels.
3 p; m5 d, ]3 G! @- DWe consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
* V# U+ k( Y8 v$ C2 @that this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
% ^3 o1 x9 S+ t$ q% E$ R, Y! nthere is evidence of both types, we contend that Canada’s
! ^6 b, h3 ]" A0 j1 p. _“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
& Z1 I+ b+ Y& `( }% {$ {  Wthe construction of too many new homes over the boom
means a deepened slump. This overbuilding will likely weigh
0 }5 q( U, |9 k  |# h( {2 I0 {2 _on markets over the next few years. Even as Canada recovers
% ^5 A2 W8 y6 W# o# w) u& mfrom the cyclical downturn, house price growth will
remain choppy and new residential construction will be
7 }: d% q9 \2 {  F) n6 l2 p( ^dampened, owing to this structural weakness. Construction
0 _1 d& q7 N5 ~: Q8 U5 K  |( Jis now undershooting fundamentals and we expect this
  J  v1 V- J7 w" i; d5 ?to 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
in the fourth quarter.
, {# p) z/ o9 B' f! vTo 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
. ^! s: x! }" J6 nprovince. Affordability is the key concept behind home
$ l3 K- F1 g1 o: y! u+ }- \values since house prices should track incomes over the
long-run. Since homebuilders build to meet demand, we
  V% d7 n' V6 V# kregard housing prices and household formation as the drivers
of residential construction.
To examine the degree of overbuilding, we employ a
/ g; e- I) z! ?+ _“counter-factual,” asking what level of residential construction
/ W$ p/ i$ t! c9 z' }, }% twould have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
# N2 m/ k% y+ m; T: m2 D9 vfundamental-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,
where housing demand will further contract under waning
3 g, U. [6 v1 Q8 l0 |( F' dpopulation inflows. Saskatoon, Calgary and Edmonton are
" w2 Z" K7 V* e5 Galready witnessing surges in their unsold new homes at the
, p. Z3 {) O: P1 W0 m- xvery time that the resale market has swung into strong
, X+ n) o0 e+ {9 Ybuyers’ territory. Homebuilding in the Atlantic provinces
4 H5 v$ I; V7 _6 M: Ghas 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
Montréal – but recent building has been relatively balanced,
2 P; d& {0 e. G4 E' ogiven 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
2 a; W- L' k5 y/ }limited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
construction mean that record numbers of condos will
, r! `" X, M7 q3 z) l9 r2 Wreach completion during 2009. If absorption rates fall, as
2 K5 j  P6 ]9 \( J6 m" B; ^cyclical factors would indicate, condo inventories could
" C7 c! G7 j: C1 Mspike severely – particularly in Vancouver. However, while
/ f7 x3 q0 j5 T- T/ b+ wresidential construction in B.C. will definitely droop, we
anticipate that the West Coast will continue to benefit from
8 X/ n5 w% M7 Ainter-provincial and international migration over the coming
years, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
6 U- ~7 N& i1 T4 h( SOVERPRICED AND OVERBUILT: CANADIAN HOUSING
! B9 Z3 ]+ V$ N1 u9 kMARKET RETURNS TO FUNDAMENTALS
% |, i0 W' w" y. P8 I* s" GGrant Bishop, Economist
416-982-8063
* ?& W7 d: v3 ^" o5 g) nPascal Gauthier, Economist
' q# g+ C$ P4 ?: Y1 L% ^0 X, q416-944-5730
2 Q5 M, h- J7 H9 j9 q
4 B5 \: ~' U& m) k  _http://www.td.com/economics/special/gb0409_housing_exec.pdf

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