TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
) I: ~5 x$ c) P. D+ Dfrom 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
3 D2 l2 i: A/ ffundamentals by approximately 9% nationwide. This
6 n( x6 W6 I- i7 O) ooverpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
3 D% N* B/ H* H- P! K# tthree years.
6 Z% d2 l( L& H4 n" P/ n0 vBy “overpricing” we mean that prices detached from
& C3 w! l; {6 I1 q( S2 H  \their fundamentals, as witnessed by a steep erosion of
% ~5 X  x7 P: ]* g( ^4 u0 ]affordability. The current unwinding of house prices reflects
7 a- ]: P5 \" f( {% B4 [/ v, Sboth a cyclical downturn and a return of house prices
to fundamentally justified levels.
3 V, H. Z; G/ `; O2 I- e( HWe consider “overbuilding” of two forms: “demanddriven”
" b' F' d- Y. z2 Nwhere homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
+ ^  i- U/ y1 b# ^& v1 cwhere builders accumulate excessive inventories. Although
& K! H/ @& z: r8 ~( Z# J. ?% lthere is evidence of both types, we contend that Canada’s
4 M4 o' E7 a+ {- A- O, o6 t“overbuilding” was mainly of the first type, where
' m* s8 J, w  Lhomebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
/ z* ]$ n# Z8 _- i# F/ }While most markets won’t face U.S.-style overhangs,
6 P& u6 c! d' ?6 l& Lthe 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
/ R( m( }' a, k9 C# efrom 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
to persist over 2009 to 2011. We anticipate that nationwide
& [0 d; }: @+ G; g4 Wresidential construction will fall further to around
. W9 H/ \2 G2 g! M4 ~4 v125,000 starts over 2009 with a trough around 115,000 units
, H% P" b0 W0 I( ^in the fourth quarter.
To 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
values since house prices should track incomes over the
$ R$ |4 ~, ]( u+ ~9 w  s: jlong-run. Since homebuilders build to meet demand, we
5 T7 n- A, \$ X8 S) u0 O3 G. uregard housing prices and household formation as the drivers
of residential construction.
To examine the degree of overbuilding, we employ a
7 S8 |1 k! |+ r5 I“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
! `9 f* t6 \9 f: R( Y+ v/ ~optimally. We find that actual homebuilding exceeded this
( V' e1 o) ]; F: v- @fundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
$ F9 d/ l8 D8 f! B5 l  kmany houses at prices that exceeded fundamentals.
& R5 ?* W3 E9 @8 B4 gRegionally, we see the greatest strains on the Prairies,
8 R0 E, p( ]& V$ H  jwhere housing demand will further contract under waning
6 U- s  q% i: u9 rpopulation inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
0 W( {  v! q9 x. L, E* v2 p! mvery time that the resale market has swung into strong
buyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
# A6 s6 l& ?4 e+ m+ I7 w$ R5 q1 yweakness, will be singed by the downturn nonetheless.
& o; F7 s5 a, {0 D! ^; \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,
7 o* y! Y8 Y1 @) K$ N8 igiven the province’s history of under-building and low ownership
rates. While Ontario homebuilding will reel from a
% l3 @. h. g; ]cyclical downturn, the degree of structural weakness appears
" A  r, [) {6 z2 N- i, ulimited – with the important exception of the Toronto
6 U7 L+ y3 y5 Wcondo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
construction mean that record numbers of condos will
- I+ l9 }, b5 l5 n* Wreach completion during 2009. If absorption rates fall, as
7 d  a/ c6 Q# T7 n9 r3 V3 [5 H% pcyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
residential construction in B.C. will definitely droop, we
+ _* }/ F' d( y$ l$ Z: B8 Ianticipate that the West Coast will continue to benefit from
. @2 _. ]; n+ t) l* minter-provincial and international migration over the coming
! \/ J: e# J1 O, L- Oyears, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
! Y2 g& z0 l2 R$ Z( {MARKET RETURNS TO FUNDAMENTALS
' j1 p2 a7 i( @Grant Bishop, Economist
" [; o& u- Y( Y& P5 x416-982-8063
8 l5 p2 V7 [5 P; D1 w- aPascal Gauthier, Economist
416-944-5730

4 \8 q) q, c+ Q9 {2 ^9 xhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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