TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
* a4 j$ T. B( `% Qfrom 2002 to 2008, unsustainable price increases drove
* c7 ~) f) D. x$ Q( p, |unsustainable levels of building. Our view is that house
prices exceeded the value of housing that was justified by
$ E2 o/ o4 D& f# }& ?6 Wfundamentals 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
three years.
: L- o' c9 |) N) w- d! pBy “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
, }% i8 ?& u  X( baffordability. The current unwinding of house prices reflects
both a cyclical downturn and a return of house prices
to fundamentally justified levels.
: X+ P3 b7 r" i& _1 PWe consider “overbuilding” of two forms: “demanddriven”
5 R9 K% F% [, ~9 Z! z, h$ Lwhere homebuyers buy up too many houses and
* o  w5 e$ T1 i& hthat this demand cannot be sustained; and “supply-driven”
2 k8 Z( g- V* X3 O! k. F3 Xwhere 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
" D9 @/ O. L8 ^( u5 dthat is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
1 o0 [) t8 q+ w# p* {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
: [& Y0 K1 S; M' j  ?+ gfrom the cyclical downturn, house price growth will
5 ]- _/ l- T( _& P9 {3 W) h% uremain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
  {) ~5 j2 I7 k' s' y# l0 e4 Ais now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
residential construction will fall further to around
1 Z" F+ v4 ~! i, ?, `125,000 starts over 2009 with a trough around 115,000 units
* Z. s& w# O; b- h) }. Z0 _in the fourth quarter.
6 x! q3 V6 r- cTo 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
' |4 O7 w2 d2 Z/ tvalues 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
; M% U0 B  [+ u. w2 c) b6 N5 |of residential construction.
% r1 N3 h5 e# z. ?. H$ N, sTo examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
! S; H3 c  v' @$ Cwould have occurred if housing had been priced
4 R) M- R7 A: G1 Xoptimally. We find that actual homebuilding exceeded this
5 G1 q4 O: \- G3 ]* y2 i, gfundamental-justified level by about 12%. Although new
% o/ S5 c' g; ?: w1 Iunits were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
$ C& ]& p+ X. \' |* B8 N+ WRegionally, we see the greatest strains on the Prairies,
) I! _5 d" R* q% u' xwhere housing demand will further contract under waning
, {6 F. @) d9 n8 x0 zpopulation inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
9 x! M$ T! i$ ?( S) uvery time that the resale market has swung into strong
buyers’ territory. Homebuilding in the Atlantic provinces
# ~1 `& j+ o7 G5 chas 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
7 m8 f- M$ M  }. Q# p2 x6 W/ Rstrange 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
rates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
1 W, t" f+ N3 A% ~4 tcondo 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
! p# p# p1 Q2 b. @9 s! G5 X: y8 I) n) Ucyclical factors would indicate, condo inventories could
8 t3 C% D( _7 c% ^* Bspike severely – particularly in Vancouver. However, while
7 d; A) |' W1 k# d8 ?8 l  Hresidential 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,
! @6 D9 }8 G+ i( ^( ^will alleviate some of the pressure from overbuilding.
) A( h5 O) M1 \% F9 t0 ~OVERPRICED AND OVERBUILT: CANADIAN HOUSING
) |. y& E) W* h6 v9 b: Z  ^) eMARKET RETURNS TO FUNDAMENTALS
2 B* W$ b3 H9 o! b( v# y+ ?3 ?Grant Bishop, Economist
416-982-8063
Pascal Gauthier, Economist
! X& V, f% W2 `5 T8 S* v% F416-944-5730
* L+ N4 `6 V5 [  @& t
, j# V# p2 B3 K: O1 S, w* L  nhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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