TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
6 e! F( t, r7 p1 [. ]5 Ufrom 2002 to 2008, unsustainable price increases drove
7 e5 B7 A! Y0 Aunsustainable levels of building. Our view is that house
$ _- r" _4 q9 Aprices exceeded the value of housing that was justified by
( F: o0 G- N1 M" ~: s4 G' ^fundamentals by approximately 9% nationwide. This
1 E* h( d# L, Q0 soverpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
) Y0 A$ Y) {) g! q5 Z4 t& @, P12%, an excess that was exaggerated in the past
three years.
$ t5 @0 B$ j; PBy “overpricing” we mean that prices detached from
  M0 D6 V* B3 Y3 ?0 t* S# btheir fundamentals, as witnessed by a steep erosion of
6 W. U3 U6 i# c! g3 l1 O& D$ Taffordability. The current unwinding of house prices reflects
+ T! Z" E" F( t7 j* G5 F9 Vboth 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
% m/ w- Z- w% E7 ythat this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
6 u- f/ e* S! }7 l0 cthere is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
# U/ m8 q/ W2 _' E0 Nhomebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
( C% {3 ~3 p; U. E" V0 m0 q# qWhile 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
remain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
0 i9 D- o8 d2 F5 Dis now undershooting fundamentals and we expect this
: ]5 K, W) n! p" Lto persist over 2009 to 2011. We anticipate that nationwide
- e/ g2 p( |* xresidential construction will fall further to around
! w" W. R* w# ?' B" a7 Q  h1 q  s125,000 starts over 2009 with a trough around 115,000 units
; d: H. {! L. u; _) ~in the fourth quarter.
1 e/ b' n% @5 _0 _( \& lTo quantify the degree of overpricing and overbuilding,
we first develop an empirical model, based on long-run
6 v& {: k* K+ s+ H( @, Efundamentals of house prices and housing starts in each
9 D4 p2 r7 o: Qprovince. Affordability is the key concept behind home
values since house prices should track incomes over the
2 F1 n: M3 b$ ~6 Flong-run. Since homebuilders build to meet demand, we
regard housing prices and household formation as the drivers
5 k% p. D7 s# X* q! w' Oof residential construction.
To examine the degree of overbuilding, we employ a
9 U. L% ^5 R  T8 s& Y. }“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
! ]  U5 s$ y! p5 Goptimally. 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.
% _: |0 g# A9 W7 T) n  {1 KRegionally, we see the greatest strains on the Prairies,
  g$ P  @& ^- @; r4 N  [9 xwhere housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
7 z& f" E: \3 Y9 u) K# Vvery 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
! A+ w" A8 X  hweakness, will be singed by the downturn nonetheless.
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,
: O& z5 U6 R! lgiven the province’s history of under-building and low ownership
2 n  T6 L7 |' [' Nrates. While Ontario homebuilding will reel from a
5 p3 r- }+ b6 [. Vcyclical downturn, the degree of structural weakness appears
5 j! A0 Q& {0 elimited – with the important exception of the Toronto
/ u: ?% {* J3 \! ^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
cyclical factors would indicate, condo inventories could
6 ]  G5 r( \% }# H# q3 Q# S+ j# o$ aspike severely – particularly in Vancouver. However, while
residential construction in B.C. will definitely droop, we
anticipate that the West Coast will continue to benefit from
7 \' U, w0 g3 C8 A9 P( p8 C* D+ Ainter-provincial and international migration over the coming
years, which, along with improvements in affordability,
, v1 Q( A3 h- N' j+ E$ n/ Ywill alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
0 ?$ z5 f7 _2 D5 k3 }# u. b4 lGrant Bishop, Economist
416-982-8063
: L! ^5 r0 y$ F& M; v1 l# FPascal Gauthier, Economist
416-944-5730
$ {* A) u2 E4 S/ s
# @3 P8 V! f. |6 m$ X; i2 qhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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