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
' a8 y* O3 G3 L, j1 w# V1 ]  Sfundamentals by approximately 9% nationwide. This
6 B5 z! ^- x. ~- u1 ]4 ~3 ^" H# |overpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
; O  `9 Z0 _6 C! j# cthree years.
) o6 {7 ~( Y' l% N* ~7 K7 u/ CBy “overpricing” we mean that prices detached from
# D5 t$ a4 {: g! k# Jtheir fundamentals, as witnessed by a steep erosion of
  z% `7 x7 \: ]. y8 V# `affordability. The current unwinding of house prices reflects
both a cyclical downturn and a return of house prices
to fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
- X1 Y% @$ q3 L0 ~where homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
# |$ _) }+ b- o6 L3 V3 awhere builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
+ C% ^6 k" J( h5 v& l“overbuilding” was mainly of the first type, where
% L. r: L. C" e% I. Nhomebuyers pushed homebuilding to an unsustainable pitch
0 M4 j: Q4 E" {& }( @that is now being rapidly reined in.
0 B: p+ F$ b4 N; ?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
: H+ N/ j% S4 m; Lon markets over the next few years. Even as Canada recovers
from the cyclical downturn, house price growth will
remain choppy and new residential construction will be
& c9 P) g! m; I% P" T* d# I5 t. Y: {1 Bdampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
$ d: m" c. S) H& |) q  \3 mresidential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
9 @* x9 r% G: K6 G# X/ H" h) DTo quantify the degree of overpricing and overbuilding,
( i* _0 R: J: q7 Bwe first develop an empirical model, based on long-run
fundamentals of house prices and housing starts in each
8 E& L* |) N( `) b6 p' x# b5 Aprovince. 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
0 X" y5 n7 r" b8 ]1 m4 aregard housing prices and household formation as the drivers
of residential construction.
  B% r2 T6 X$ z$ ^8 t$ K9 tTo examine the degree of overbuilding, we employ a
4 F( a$ H9 u1 m; f, }+ |“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
5 |$ M7 s; j2 {; m; `optimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
9 t$ ~$ w: R# L# H7 W& Dunits were being absorbed, homebuyers simply bought too
& ~, ~* a+ p- ^# K0 Y5 cmany houses at prices that exceeded fundamentals.
8 _$ Q7 t; H3 C5 O! g% `8 ORegionally, we see the greatest strains on the Prairies,
* \$ c5 r! Q& v3 D2 X, m) K  l* i$ c3 cwhere housing demand will further contract under waning
, J' N7 @3 O( O0 {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
9 H, S+ I- f* T0 X+ {; X5 Abuyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
- r& G/ e) x; fweakness, will be singed by the downturn nonetheless.
# H6 ^  h) v; u5 vQuébec shows signs of strain – especially given the
strange accumulation of unabsorbed multiples on l’Île de
Montréal – but recent building has been relatively balanced,
# |7 H3 |$ o- ]# v- l7 Y; kgiven the province’s history of under-building and low ownership
. Y3 e/ h- D6 h/ Irates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
1 E3 E% a, y- L# I' E0 Dcondo market. Both in Toronto and Vancouver, historically
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
( `8 A0 T* u, G+ i, }spike severely – particularly in Vancouver. However, while
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
1 w: R1 e$ v) S# x. Xyears, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
% G. B# H! G6 R0 s% V) [7 wOVERPRICED AND OVERBUILT: CANADIAN HOUSING
8 L% M" T1 [" }- I0 F3 iMARKET RETURNS TO FUNDAMENTALS
7 \6 S7 `7 I1 \# X& a. k5 yGrant Bishop, Economist
416-982-8063
! ]" t/ x0 }( Y- RPascal Gauthier, Economist
% Z- Z. n* t/ b" ~9 F- e1 g416-944-5730

& b" L4 D  g1 [1 S- whttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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