TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
/ z$ N/ O$ T' Wfrom 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
$ b3 Q% F& x$ C- e% goverpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
" \% d$ c' M9 R+ Y12%, an excess that was exaggerated in the past
% w8 {& A% \3 vthree years.
, h+ w' y$ v# |( w( J. nBy “overpricing” we mean that prices detached from
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
2 E$ ^6 w: g8 |* v( sto fundamentally justified levels.
! o; \4 x( g, F4 s- L+ GWe consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
! o+ u8 l& H, Xwhere builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
3 l1 ~, M: T- u* E8 ]& L“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
8 N. W/ @; j$ y$ ]8 p, r0 bthat is now being rapidly reined in.
2 w0 s: J6 q* L4 uWhile most markets won’t face U.S.-style overhangs,
+ y* E; z4 @% z  u# l% b  Y2 Fthe 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
% V* w0 U. T! A6 W) ^+ wremain choppy and new residential construction will be
1 h2 U* q( k* D1 b4 f$ H, x6 ^dampened, owing to this structural weakness. Construction
3 x+ O( I* \& `5 `3 N% eis now undershooting fundamentals and we expect this
- S' _0 y0 |5 c2 t" n, T; rto persist over 2009 to 2011. We anticipate that nationwide
residential construction will fall further to around
. A+ ]& a% C: F( v0 v125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
To quantify the degree of overpricing and overbuilding,
; I3 l' o/ i- U  Iwe 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
' o/ i% o9 c" c# Gvalues since house prices should track incomes over the
( W* |5 b  l) D8 t7 d& k2 _long-run. Since homebuilders build to meet demand, we
6 |9 U9 Y% E, D, A# @regard housing prices and household formation as the drivers
of residential construction.
To examine the degree of overbuilding, we employ a
# v1 m3 E+ G2 W; D- }: a: w& r“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
# U( O/ C$ j& r8 Q# ?9 |many houses at prices that exceeded fundamentals.
+ ?4 z# K6 ?' c% jRegionally, we see the greatest strains on the Prairies,
8 D/ B* v: j$ F- T; @8 {3 Gwhere housing demand will further contract under waning
1 {. E8 t- s0 ?% f" P8 i* t$ E% jpopulation inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
% V* Z% Q9 S* y8 ]/ gvery time that the resale market has swung into strong
/ E5 f& c' w" Jbuyers’ territory. Homebuilding in the Atlantic provinces
3 ~+ v% p1 P: B6 `. X* I8 s  l. Phas been relatively balanced but, while not plagued by structural
, _3 @$ t+ l' F) P0 \' y, Z- Cweakness, will be singed by the downturn nonetheless.
, `8 f) w6 N+ k0 {; I' \Québec shows signs of strain – especially given the
# H; ^/ Y! E! K7 l1 y$ k3 z6 istrange accumulation of unabsorbed multiples on l’Île de
Montréal – but recent building has been relatively balanced,
given the province’s history of under-building and low ownership
% f( v3 p: f. ]7 C0 H& ^1 v2 S! e1 frates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
6 r5 ~8 v: x& U+ [$ Dlimited – with the important exception of the Toronto
3 k. n& w/ \: t4 Z! ]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
* j/ p- i/ U8 n1 N, t' q9 |/ Fspike severely – particularly in Vancouver. However, while
% B* a9 d. l- f& F9 jresidential construction in B.C. will definitely droop, we
5 b, @  a! M1 ?& {- ^anticipate that the West Coast will continue to benefit from
0 i6 b- i) R3 f# |# t' P+ d1 Finter-provincial and international migration over the coming
7 T( K9 Y3 i# jyears, which, along with improvements in affordability,
( ]  y# h) L6 L$ W6 i9 Iwill alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
Pascal Gauthier, Economist
; J/ |6 _" }' F' ^416-944-5730
- g- O# k$ D8 G0 x( s
http://www.td.com/economics/special/gb0409_housing_exec.pdf

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