TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
& e& E% m, R' efrom 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
) p+ s6 D) x7 Q7 j( G8 M0 Pfundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
" V" _# x8 @$ t* P- C  T2 R& \9 f12%, an excess that was exaggerated in the past
three years.
By “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
: e9 J! f3 M! ]2 t( y+ gboth a cyclical downturn and a return of house prices
to fundamentally justified levels.
7 o  C/ a9 y) X- D" xWe consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
$ i( f3 f9 H& g" L# swhere 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
that is now being rapidly reined in.
$ C" z. i4 {) u* O$ Q& w8 d5 [While most markets won’t face U.S.-style overhangs,
the construction of too many new homes over the boom
8 `2 P/ L$ {: \1 k: I+ ?6 I- ?# Vmeans a deepened slump. This overbuilding will likely weigh
' i+ u/ ]7 Y+ Ron markets over the next few years. Even as Canada recovers
$ f. t& @. g  |' {+ Dfrom the cyclical downturn, house price growth will
. p* X- S/ I7 n$ M+ p  dremain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
/ N4 _% p8 L# [" i% [3 ois now undershooting fundamentals and we expect this
- {5 T, B  O: A- i% Pto persist over 2009 to 2011. We anticipate that nationwide
6 D; ]; Q3 B9 i% f, O5 xresidential 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,
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
$ Q/ ]7 d# H( ^2 e$ C/ i# hvalues since house prices should track incomes over the
8 b3 }: d$ N0 F0 u/ {' [4 Nlong-run. Since homebuilders build to meet demand, we
) V  y, S+ [( O; Q- V7 e8 Q) lregard housing prices and household formation as the drivers
of residential construction.
) v" \) \- u% JTo examine the degree of overbuilding, we employ a
& P& _% `0 D6 h! S+ n- M“counter-factual,” asking what level of residential construction
3 A% I3 y4 m2 z2 G' X6 ]' w! ?would have occurred if housing had been priced
! a0 v" d0 N# moptimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
0 b4 D) f. K6 uunits were being absorbed, homebuyers simply bought too
: ?( v; r4 ^% I& W5 _many houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
: n3 c' A6 p6 D9 O7 Cpopulation 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
# ^2 ~$ v; I+ A; R! `, a7 q; P5 E. O# tbuyers’ territory. Homebuilding in the Atlantic provinces
6 }2 h, b" `- u2 Dhas been relatively balanced but, while not plagued by structural
weakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
! x9 o* d, T/ r) W2 _' `3 Bstrange accumulation of unabsorbed multiples on l’Île de
Montréal – but recent building has been relatively balanced,
' r% p, O7 t+ ~given the province’s history of under-building and low ownership
& @: e$ S# \! o: e7 y. x! I5 frates. 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
0 H) o. l6 A" [7 A2 }construction mean that record numbers of condos will
' a) \8 g$ ~$ Lreach completion during 2009. If absorption rates fall, as
) f( V- t1 Z0 a* a% [cyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
2 Y3 l4 A# S9 {4 w: mresidential construction in B.C. will definitely droop, we
: w9 E7 \, F  v! l* j9 uanticipate that the West Coast will continue to benefit from
inter-provincial and international migration over the coming
years, which, along with improvements in affordability,
- o7 H* [' X$ b  z) w& j, r# nwill alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
- f* A( D3 W7 r3 i" f/ f* f- |' \MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
5 S4 |) Y; A7 M/ E! dPascal Gauthier, Economist
* V. A5 s! E; u" A416-944-5730
: I1 n4 W/ q  `  W: A
5 e" L2 ~- e" r. Qhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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