TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
( {! B; B5 O; s) S) y! c4 _% Sfrom 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
fundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
1 T/ w! Q1 l( r% X& ^# U7 e4 t$ qthree years.
By “overpricing” we mean that prices detached from
; S! E% k5 ^% {5 d! M. K9 T# _their fundamentals, as witnessed by a steep erosion of
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”
where homebuyers buy up too many houses and
% ^2 H6 ^, f9 J/ zthat this demand cannot be sustained; and “supply-driven”
9 F; ], B6 j0 s1 S/ v! U6 @where builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
3 }4 K+ L$ U, s8 s3 x“overbuilding” was mainly of the first type, where
homebuyers 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
+ i* R6 i2 v5 ^$ w! d& g% Afrom the cyclical downturn, house price growth will
remain choppy and new residential construction will be
1 [0 ]4 P+ V2 O2 b0 u* `/ sdampened, owing to this structural weakness. Construction
* c/ p- T# |7 c' d! N0 p; ]is now undershooting fundamentals and we expect this
0 @! _. w1 g' Z8 {) [5 _5 \) Hto persist over 2009 to 2011. We anticipate that nationwide
  v+ I! S; y; _, ?1 U) n. T& hresidential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
  X0 o8 p) u& P2 r4 V# @in the fourth quarter.
To quantify the degree of overpricing and overbuilding,
! I5 f* C- a# `' U! m  Cwe first develop an empirical model, based on long-run
+ s2 c) I, ~9 M# ?9 dfundamentals of house prices and housing starts in each
0 C- L8 j" l' w& Mprovince. Affordability is the key concept behind home
! B) ]0 `4 j  X% x7 ^: Qvalues since house prices should track incomes over the
% r( T9 q) K  r, L, h, ^long-run. Since homebuilders build to meet demand, we
: F" _/ e% \1 [4 T5 h6 mregard housing prices and household formation as the drivers
of residential construction.
* n: z) `+ z; k8 M. k2 F! q2 GTo examine the degree of overbuilding, we employ a
& C. L5 H# [. ^' w; C( _“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
. v8 e3 ?  R& {. woptimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
  I3 X! P/ J$ B% sunits were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
! ~" v  v0 [' a; pRegionally, we see the greatest strains on the Prairies,
: H' ^2 j8 Q. [6 ^where 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
buyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
* E5 ~. U, F) mweakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
strange accumulation of unabsorbed multiples on l’Île de
+ H# a7 k4 z7 e, N; z3 M9 W$ SMontréal – but recent building has been relatively balanced,
$ y" w, y" V( I9 D, B+ n1 N8 b* Mgiven the province’s history of under-building and low ownership
rates. While Ontario homebuilding will reel from a
4 Z; o; o3 c' xcyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
0 c- l4 f  J& H- X2 lhigh levels of apartment-style units presently under
5 z& |2 Z. W6 X  @7 G; Q1 kconstruction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
. E# d  y; q2 j. `7 q3 Acyclical factors would indicate, condo inventories could
; S/ X. O9 J% Kspike severely – particularly in Vancouver. However, while
residential construction in B.C. will definitely droop, we
9 x* |( t" t* x. ?4 j$ U7 O6 R+ m$ fanticipate that the West Coast will continue to benefit from
# y) G$ W- {8 `9 e! }inter-provincial and international migration over the coming
years, which, along with improvements in affordability,
0 c. T+ h3 R. |2 a+ \) v0 kwill alleviate some of the pressure from overbuilding.
- i2 y. @7 i* c3 S+ p# E4 mOVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
" O8 e4 c5 @* M4 cGrant Bishop, Economist
; w  B; R1 T' o; ~6 C416-982-8063
Pascal Gauthier, Economist
416-944-5730
* h. N) E: j' t
: m' f8 ~$ j! M! z8 ahttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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