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
" C. \) g$ q2 z6 X3 t# _! Kprices exceeded the value of housing that was justified by
% d1 L# n# a0 Y# wfundamentals by approximately 9% nationwide. This
3 k  z4 B' ^9 J2 Goverpricing compelled a level of residential construction
, q2 V1 J- A/ b& b4 p$ kthat exceeded its fundamental-justified level by approximately
) q. Y8 Y. o$ `2 Z! Q7 r; }7 H12%, an excess that was exaggerated in the past
" s6 p& S% p  ]2 D5 Rthree years.
By “overpricing” we mean that prices detached from
7 x! M# j& b+ Z2 P5 ?3 t& htheir fundamentals, as witnessed by a steep erosion of
: b, ~& w4 b- ^8 k$ a! i" R0 O1 Kaffordability. The current unwinding of house prices reflects
& P- N2 {; C# M5 ^both a cyclical downturn and a return of house prices
; ]- F8 V# K" g1 o, D2 Zto fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
: |- z' [! b7 Z6 x# {that this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
there 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
7 ^- S0 g% q" C: S# K6 i4 Qthat is now being rapidly reined in.
4 _4 ~/ U8 A$ N' P$ G8 `" W: mWhile 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
" A+ a( W; \) B+ {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
9 q8 I* H) x! Z1 x, i8 gis now undershooting fundamentals and we expect this
. J- C( g2 i4 Fto persist over 2009 to 2011. We anticipate that nationwide
8 H$ D( t8 n5 H$ w& ?! u# D  Xresidential construction will fall further to around
! S5 B1 m3 z* P; v9 m& p9 @, V125,000 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
- {" E* N( ~6 k+ ~4 Bfundamentals of house prices and housing starts in each
, J. H& k8 Q! f2 e- n( f1 Kprovince. Affordability is the key concept behind home
values since house prices should track incomes over the
5 w2 ^" [- G4 d) z# ?# V- G! C( Jlong-run. Since homebuilders build to meet demand, we
$ P2 @  ~/ O1 [4 Pregard housing prices and household formation as the drivers
of residential construction.
" Z2 _+ X8 {( i8 ]1 JTo examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
fundamental-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,
) o8 `+ S- v# jwhere 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) G4 s9 @$ Q: Ebuyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
5 {- C7 N1 T3 g/ oweakness, will be singed by the downturn nonetheless.
" O% [1 l+ Z" g- |2 mQuébec shows signs of strain – especially given the
9 @! f7 _8 s% W# p. q% o$ V0 Lstrange accumulation of unabsorbed multiples on l’Île de
Montréal – but recent building has been relatively balanced,
7 G( I9 i+ d1 R' h; Ugiven the province’s history of under-building and low ownership
2 @6 A% \' Z7 F5 T5 Z1 ^& wrates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
$ u5 C! n2 I# A# i& h3 i/ \: ]construction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
7 [/ [- i) J: E8 qspike severely – particularly in Vancouver. However, while
! D7 [# q0 \  s) |, M1 p4 C% D/ lresidential construction in B.C. will definitely droop, we
# h( O+ q, P# j" S$ F, {anticipate that the West Coast will continue to benefit from
5 O, [+ L8 a9 }6 Pinter-provincial and international migration over the coming
, N( f+ N& a% B6 A/ Cyears, which, along with improvements in affordability,
% e4 f0 @% G/ X# r0 \0 Lwill alleviate some of the pressure from overbuilding.
& g/ h! f; R+ w; u: O! fOVERPRICED AND OVERBUILT: CANADIAN HOUSING
/ W# {# |# z* B9 R0 `; uMARKET RETURNS TO FUNDAMENTALS
$ d4 R* m! \" w7 rGrant Bishop, Economist
416-982-8063
2 E; w9 S7 y2 Z  h, y, lPascal Gauthier, Economist
416-944-5730

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

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