TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
: j. d$ v6 ?- X6 ^8 {3 }from 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
0 f: O' |: o9 S7 dfundamentals by approximately 9% nationwide. This
, @' n3 p3 e6 t" N" boverpricing compelled a level of residential construction
0 w4 `% Y* W! E& o0 W* s" A* Athat exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
three years.
# \. G  [2 m5 o1 `By “overpricing” we mean that prices detached from
- ^9 A3 w9 X% \their fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
% C; [: N% r! z7 xboth a cyclical downturn and a return of house prices
9 z5 q, Q. Q) Q7 o% {- oto fundamentally justified levels.
. {' h( i3 e  d% u5 xWe consider “overbuilding” of two forms: “demanddriven”
9 C% T9 J! p2 ^0 b2 fwhere homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
0 L+ B9 p+ s! Y4 S9 M5 Q' Zthere 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
4 l8 n) A5 P2 ythat is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
2 U& g: @+ E, d* L/ E: rthe construction of too many new homes over the boom
5 Q' T* {0 s$ V! u) Q7 q* Cmeans a deepened slump. This overbuilding will likely weigh
on markets over the next few years. Even as Canada recovers
$ \* I3 l5 K$ x# S* q& d8 qfrom the cyclical downturn, house price growth will
3 s  s( j' p  Sremain choppy and new residential construction will be
: [# X+ U) y( l2 p% `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
residential construction will fall further to around
8 C  Q) F% Z. H1 n9 H$ M. |) ^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
; S% R9 P( u. y1 j% }fundamentals of house prices and housing starts in each
province. Affordability is the key concept behind home
: b' o7 L, v: i4 k) N2 W/ mvalues since house prices should track incomes over the
long-run. Since homebuilders build to meet demand, we
regard housing prices and household formation as the drivers
of residential construction.
+ A1 L% u" g3 tTo examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
$ X9 m  q( g. _5 z6 Iwould have occurred if housing had been priced
+ K& @8 z/ `  Y+ ]3 S7 aoptimally. We find that actual homebuilding exceeded this
+ D3 F7 o% L4 L9 n3 c( cfundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
' S# t/ ]. Z2 w9 E9 M8 J( f, wmany houses at prices that exceeded fundamentals.
: k& L* o  R# F6 q$ e+ ^Regionally, we see the greatest strains on the Prairies,
5 Y3 u; S7 ]" v' R+ r3 g5 pwhere housing demand will further contract under waning
, E1 f; \/ i) I& y2 Fpopulation 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
( w7 O+ a9 a- o3 _6 o! z% zhas 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
strange accumulation of unabsorbed multiples on l’Île de
# D1 ~1 \7 z+ H! E, EMontréal – but recent building has been relatively balanced,
given the province’s history of under-building and low ownership
* Q0 V$ \0 c9 m; e7 H& L& w7 T# vrates. While Ontario homebuilding will reel from a
. G  h' A' L' n- Ecyclical downturn, the degree of structural weakness appears
2 a7 P8 x, x! ?3 E( qlimited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
1 f* X, ]' j+ Kconstruction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
6 W  m4 j, R+ M1 Y2 h0 s" T: Q$ M( G, j  lcyclical factors would indicate, condo inventories could
spike 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
inter-provincial and international migration over the coming
years, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
' w: F3 a9 J( WOVERPRICED AND OVERBUILT: CANADIAN HOUSING
& y- o$ k$ e; }2 ~% F/ N8 a/ s& X: iMARKET RETURNS TO FUNDAMENTALS
, `, L2 X$ l* i4 m8 M- O9 K, VGrant Bishop, Economist
416-982-8063
4 Y/ P6 X  C; o# f5 o/ V2 E* ?5 }. u9 yPascal Gauthier, Economist
8 y' Q  i  G" a% }5 L6 W1 @416-944-5730
# q' \+ }" d* o1 p. }/ G
# p/ S/ W- V  ~# G/ M5 r. n* u& m+ Rhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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