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
, A3 a' d" K2 [- z$ Bfundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
( Y* \2 ?% r9 V, G! E( E9 bthat exceeded its fundamental-justified level by approximately
8 K/ I& r7 }8 R* Q7 n12%, an excess that was exaggerated in the past
5 [1 w2 u3 c3 f' ^three years.
By “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
, d1 u+ z6 q1 }" T# ?* A$ [: {affordability. The current unwinding of house prices reflects
' m+ L. J1 c9 o$ nboth a cyclical downturn and a return of house prices
to fundamentally justified levels.
6 s5 w# q' j9 |4 v* sWe consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
2 t' X* I6 O7 ?; T$ W7 dthat this demand cannot be sustained; and “supply-driven”
8 m+ X) r: I5 G/ q* g$ nwhere builders accumulate excessive inventories. Although
2 X# [! s" `/ R% @there is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
3 Z; E7 s( m9 ]. u- d9 q- Fhomebuyers pushed homebuilding to an unsustainable pitch
that 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
means a deepened slump. This overbuilding will likely weigh
on markets over the next few years. Even as Canada recovers
from the cyclical downturn, house price growth will
+ p# X' k8 o. p2 g7 Hremain choppy and new residential construction will be
% C; M2 A' g: B6 f0 F6 odampened, owing to this structural weakness. Construction
; o7 I3 t. S9 N3 E9 d2 [; {is now undershooting fundamentals and we expect this
, H% k8 n- P" ~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.
To quantify the degree of overpricing and overbuilding,
, v* n3 a1 m% m( N* {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
  E; l, r+ s5 V; n. rvalues since house prices should track incomes over the
long-run. Since homebuilders build to meet demand, we
+ w; c0 f' [1 m& `- kregard housing prices and household formation as the drivers
. X9 a# D4 E7 q3 cof residential construction.
7 N5 \, P/ n- w0 k6 d  PTo examine the degree of overbuilding, we employ a
; E" p; K# b! K5 S, I; }: f“counter-factual,” asking what level of residential construction
) P, L( l) m0 i2 f/ A( A% Xwould have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
/ n. o! ^* R/ i5 ?  N4 cfundamental-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,
7 r/ U/ K" i- @  a* awhere housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
2 j3 J) [6 J; H; a7 Lalready witnessing surges in their unsold new homes at the
& {$ n1 |2 W* i2 x$ hvery time that the resale market has swung into strong
! V; U4 M- f3 h" kbuyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
weakness, will be singed by the downturn nonetheless.
4 ^4 b. g! y! b, P+ W& c" YQuébec shows signs of strain – especially given the
strange accumulation of unabsorbed multiples on l’Île de
Montréal – but recent building has been relatively balanced,
- D1 V: S/ T3 pgiven the province’s history of under-building and low ownership
8 \/ K  D: y5 Vrates. While Ontario homebuilding will reel from a
7 A8 c! O' T: @2 {, h" Kcyclical downturn, the degree of structural weakness appears
; Z# X- [$ u: \. h: l$ Alimited – 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
reach completion during 2009. If absorption rates fall, as
" S6 _. C1 A0 D0 l1 scyclical factors would indicate, condo inventories could
" _3 o+ V5 a% x% R, ospike severely – particularly in Vancouver. However, while
% D" j0 Z8 X& a% L2 R* u, U( vresidential 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
- B( y" H/ r4 z* L- N( byears, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
  U/ P. d# x, o3 y; c3 lOVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
- d4 a' k7 b! n# Q, o& I. Q416-982-8063
! s! g) Z8 Q% ^* g' i$ s9 T1 c: {. U. UPascal Gauthier, Economist
416-944-5730
5 u0 J0 X. E) A0 p$ g- b
http://www.td.com/economics/special/gb0409_housing_exec.pdf

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