TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
( \1 }/ N  H& {1 t& }from 2002 to 2008, unsustainable price increases drove
unsustainable levels of building. Our view is that house
6 X1 ~4 z  W5 t' F9 xprices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
& h8 ~7 ~( y5 A4 W& w) Q* nthat exceeded its fundamental-justified level by approximately
1 I( c9 P* w+ y$ F. A7 o12%, an excess that was exaggerated in the past
three years.
By “overpricing” we mean that prices detached from
) H) r. }( B$ m* q# N/ M% _their fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
/ U, e3 G3 ~2 ~both a cyclical downturn and a return of house prices
to fundamentally justified levels.
) p. i! l3 t2 pWe consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
8 f% N1 Y+ S' D" ethat this demand cannot be sustained; and “supply-driven”
+ X, v- x& C/ e  Twhere builders accumulate excessive inventories. Although
, N  d( `$ E9 ~there is evidence of both types, we contend that Canada’s
* {/ C( t7 C0 b7 O' M, M/ M" T“overbuilding” was mainly of the first type, where
: V8 X+ R3 ~. e( ~' ^homebuyers pushed homebuilding to an unsustainable pitch
) H# a% A/ \! x( Z9 a- Gthat is now being rapidly reined in.
. R3 H4 r2 l, l; @# d, w3 B  U+ aWhile 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
- w- r( i9 e; Q, ?from the cyclical downturn, house price growth will
7 ?( f. L& L2 j9 j8 v8 Oremain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
- O! ~0 i2 W, X6 [7 r  v8 A- g/ \is now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
: B. Z  ~( r4 Y9 Q+ uresidential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
1 h1 ^; I) C! n, U: H4 F: ?in the fourth quarter.
% C% w0 a" `0 [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
: k/ z- u; V) i2 wvalues since house prices should track incomes over the
) l  P9 T9 v7 K2 x: qlong-run. Since homebuilders build to meet demand, we
3 H: q9 W1 Q, {; U, J7 g' I7 N/ uregard housing prices and household formation as the drivers
of residential construction.
: u, s, F& b, S3 r7 [* G4 O+ _- j5 u5 PTo examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
6 B$ p0 q3 o  {fundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
8 F. ~9 X% Q- Tmany houses at prices that exceeded fundamentals.
# j9 @7 V+ `4 h# l# xRegionally, we see the greatest strains on the Prairies,
9 r. G( E, D6 w7 D& m- pwhere housing demand will further contract under waning
" Z8 l  m% u) [; s3 B, N5 m, ~7 Gpopulation 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
! `+ ~3 {! H* [" l! r4 X8 bbuyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
1 P- Y  N8 D' s' ^weakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
; M* g$ f6 |8 dstrange 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
- w0 L: z. ?4 U( Arates. While Ontario homebuilding will reel from a
: R+ g$ F! a4 R9 Dcyclical downturn, the degree of structural weakness appears
6 O/ ?) I* K" @+ r; }1 Qlimited – with the important exception of the Toronto
9 `+ s( N. t9 d* t6 w3 Qcondo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
0 B" x% ?1 R+ G( A' `7 t# ?7 G) W+ |% qconstruction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
3 H* m" A; Y* F+ |spike severely – particularly in Vancouver. However, while
residential construction in B.C. will definitely droop, we
+ w* W, m. J' F5 j1 tanticipate that the West Coast will continue to benefit from
2 ]/ ~8 ?+ k7 @3 ointer-provincial and international migration over the coming
years, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
( b& I. ^# i% FMARKET RETURNS TO FUNDAMENTALS
/ e& F1 c# r  Y* }Grant Bishop, Economist
9 Y- ^+ c1 V+ M1 b1 g9 \416-982-8063
2 N5 {  I4 }3 J' `7 w2 LPascal Gauthier, Economist
  _" B4 [( ^9 ~6 \3 |  t416-944-5730

- P" }* U* ~% {; K9 B4 ^- Fhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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