TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
3 R8 X' ~( x5 X4 J, `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
fundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
. S" h) d2 |6 Hthat exceeded its fundamental-justified level by approximately
% q! B# k* S- ?5 t  Q2 v* p12%, an excess that was exaggerated in the past
5 X- M) w: A) f% ?& Fthree years.
) {# F5 P" W# ZBy “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
0 B& R: J8 M+ ~8 `3 @; {9 Oto fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
, g3 I* |3 s) Q% [# o9 k" uwhere homebuyers buy up too many houses and
6 w6 U# a, C& ]that this demand cannot be sustained; and “supply-driven”
% s7 [& f/ e; M9 j- Bwhere builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
& A/ ^( h0 K$ m/ W: \“overbuilding” was mainly of the first type, where
- d0 b: c# W7 F7 E9 U# G, o% vhomebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
8 I6 k: U' G8 f( bWhile most markets won’t face U.S.-style overhangs,
% Y& A7 S5 {# N/ [- @the construction of too many new homes over the boom
  [9 y5 R5 V& R. @' zmeans a deepened slump. This overbuilding will likely weigh
& e, @2 W2 w6 y% w; A3 c) p/ ton markets over the next few years. Even as Canada recovers
2 _+ Y7 T* I  X' p, B6 gfrom the cyclical downturn, house price growth will
/ K6 M; d! A4 fremain choppy and new residential construction will be
6 `  P- |" B3 }8 N5 |, `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
, i- o* s& c' d2 e" c0 }125,000 starts over 2009 with a trough around 115,000 units
& T9 D& b- q8 u/ p4 T" {in the fourth quarter.
To quantify the degree of overpricing and overbuilding,
we first develop an empirical model, based on long-run
/ w! z5 e, |7 S1 x% hfundamentals of house prices and housing starts in each
province. Affordability is the key concept behind home
values since house prices should track incomes over the
* y7 f& s' C, c+ Z1 `5 D5 slong-run. Since homebuilders build to meet demand, we
6 r  T/ z1 u+ _6 }9 y) Mregard housing prices and household formation as the drivers
# q+ K+ |; }$ A! s5 hof residential construction.
To examine the degree of overbuilding, we employ a
7 Y* E! C- v8 Y/ ~( j" e! m: s2 {“counter-factual,” asking what level of residential construction
" Y0 q! g* D" s! V* T" ~* w/ ]would have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
, }. f9 R2 W3 s4 Y5 G) bfundamental-justified level by about 12%. Although new
3 h  E3 x: g5 t- g/ T& Junits were being absorbed, homebuyers simply bought too
+ k* i$ k# O, ]many houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
% x9 r: b3 R$ D& w0 ]where housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
, T! o, z2 l5 E" U: z; ?very time that the resale market has swung into strong
buyers’ territory. Homebuilding in the Atlantic provinces
, g1 N' D' I2 e2 c! E1 u  r* O5 xhas been relatively balanced but, while not plagued by structural
9 A' T, N3 A* [) m' C0 Eweakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
3 d: b: E, F; p4 _( W0 B0 hstrange 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
7 n+ p- E6 B, w1 g: _4 Zrates. While Ontario homebuilding will reel from a
. K/ d7 R5 W" \$ p$ @% }! ?$ dcyclical downturn, the degree of structural weakness appears
3 L5 H# r0 A; }  d! B- klimited – with the important exception of the Toronto
3 ?7 u- e# |; C! T# s! ucondo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
1 f, U) W( `* s+ @construction mean that record numbers of condos will
6 O' b; e. a: F( k1 \reach completion during 2009. If absorption rates fall, as
* ~% u5 q( V# z, k: h8 @# lcyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
residential construction in B.C. will definitely droop, we
% U. ^+ W6 U! v5 b8 Eanticipate that the West Coast will continue to benefit from
& t6 D, ^: S; `% einter-provincial and international migration over the coming
8 u# t" S1 w9 f4 S- W3 u2 n0 Yyears, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
' f! C* ^: R7 S8 O/ lPascal Gauthier, Economist
416-944-5730
1 b, I; z5 h! _" w2 t
' B2 M1 u5 P% U3 m- V0 \http://www.td.com/economics/special/gb0409_housing_exec.pdf

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