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
2 r8 _2 E9 Y1 Y; S) S4 Uunsustainable levels of building. Our view is that house
( Q% l$ b7 p: o3 b+ R: X2 g# Q: p3 Wprices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
  N+ I: C, K* Y$ i2 b* toverpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
  C; o1 A. h! y: z- Z& R* s6 t12%, an excess that was exaggerated in the past
# c$ Z4 c, J+ A0 rthree 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
# Z* K8 ?' B1 J" R% N6 Hboth a cyclical downturn and a return of house prices
. S/ ^' Y; i/ y& M- D5 u& P* Zto fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
0 [% n  u- I& \9 y4 O8 Rwhere homebuyers buy up too many houses and
" Y+ N1 d1 [8 Z- Pthat this demand cannot be sustained; and “supply-driven”
  x& k% V: k/ H' S2 `, O* o$ Kwhere builders accumulate excessive inventories. Although
8 G# {, k( H! _# pthere is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
+ F; K' T' z" x1 ?3 D2 _; f4 pthat is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
the construction of too many new homes over the boom
% h6 @8 w7 a1 z% Lmeans a deepened slump. This overbuilding will likely weigh
' X" ^  A. m0 G! [on 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
dampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
& N! ]' `  c6 ]" rto persist over 2009 to 2011. We anticipate that nationwide
residential construction will fall further to around
4 p" `2 V) c9 L125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
( z, G8 b7 s) m( h; S1 aTo 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
province. Affordability is the key concept behind home
# o1 t4 D8 o* q. xvalues since house prices should track incomes over the
* ~- f6 K: E/ W+ plong-run. Since homebuilders build to meet demand, we
regard housing prices and household formation as the drivers
% y$ I% ?2 S6 N! r, Z* |: yof residential construction.
To examine the degree of overbuilding, we employ a
4 i4 C1 V& f0 q6 S: A5 H8 V2 N“counter-factual,” asking what level of residential construction
1 J# e* N$ F( R* F9 n: Uwould have occurred if housing had been priced
9 Q, i+ q1 `6 K1 X0 a8 D+ q( ?optimally. We find that actual homebuilding exceeded this
1 p. E4 ]2 I: ffundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
/ i% M- f1 p3 y' R9 r7 Umany houses at prices that exceeded fundamentals.
& ^0 u6 g$ Z9 h2 bRegionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
6 [( C3 ~7 k: U# n) N" H' @! balready witnessing surges in their unsold new homes at the
; k" J) i& V/ X7 j  E% Ivery time that the resale market has swung into strong
buyers’ territory. Homebuilding in the Atlantic provinces
9 h! _4 b$ s9 [1 [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
strange accumulation of unabsorbed multiples on l’Île de
9 o& ^' c; ^" [Montréal – but recent building has been relatively balanced,
1 }1 I0 h. A* l( d4 E! k& Igiven the province’s history of under-building and low ownership
rates. While Ontario homebuilding will reel from a
% B& z* o9 F8 Z$ Y4 rcyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
2 ]3 {6 W% J, ?( _0 `$ jhigh levels of apartment-style units presently under
construction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
0 b, Y6 R8 o7 f, |0 J" {; q, _cyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
residential construction in B.C. will definitely droop, we
: [; N% A( ]3 C' C8 k$ ]+ E" tanticipate that the West Coast will continue to benefit from
% i% p! i; R; ]6 binter-provincial and international migration over the coming
- s+ g1 |# i: I2 u4 H1 Pyears, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
2 m( k2 q- `8 Z6 X* A* Y+ u6 F416-982-8063
Pascal Gauthier, Economist
& \; K( \5 H1 h8 G  a* A, Z416-944-5730
( v6 w  H% T; \4 D
6 d- X0 j& m, o2 y$ i$ xhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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