TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
from 2002 to 2008, unsustainable price increases drove
unsustainable levels of building. Our view is that house
9 w! O" ?+ u3 G, F! Fprices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
; C2 m7 x1 |! f% M+ U7 u% uthat exceeded its fundamental-justified level by approximately
* s3 H: z3 x9 @  r2 g12%, an excess that was exaggerated in the past
3 P$ J, _. c; @5 d3 R5 ~three years.
By “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
to fundamentally justified levels.
. o1 ?2 \/ K, V  ]5 {1 F9 x& C% nWe consider “overbuilding” of two forms: “demanddriven”
" `/ q- U+ M' q. Wwhere homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
$ M+ }7 z" G' V+ z& v# c0 |# fwhere builders accumulate excessive inventories. Although
9 s7 v0 U2 Y5 N$ b0 kthere is evidence of both types, we contend that Canada’s
5 I3 m$ o# e- ^0 M8 S9 C“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
, d6 S1 y$ T' k6 Gthe construction of too many new homes over the boom
6 N/ W$ x2 |) |2 |5 B# Ymeans a deepened slump. This overbuilding will likely weigh
: T( z6 c6 L# g5 J: c6 X+ A) kon markets over the next few years. Even as Canada recovers
0 L$ j% L% G. w0 Yfrom the cyclical downturn, house price growth will
& o9 i( F. R: `: H) Xremain choppy and new residential construction will be
8 q$ |, n- q6 \& B7 h3 o* odampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
& q$ ]1 g4 q" x4 ~; }) _to persist over 2009 to 2011. We anticipate that nationwide
/ X7 A6 _9 a3 b3 Hresidential construction will fall further to around
0 o  P$ X$ E' u/ }* Y" z! b) B125,000 starts over 2009 with a trough around 115,000 units
1 w% Y0 W8 C) |. Y) Q/ V0 ^% qin the fourth quarter.
To quantify the degree of overpricing and overbuilding,
' ?: P: ~; H0 U- b3 O  mwe first develop an empirical model, based on long-run
* G; ~) M' O* }/ mfundamentals of house prices and housing starts in each
province. Affordability is the key concept behind home
8 f- m6 P$ O& J9 y' ^% {9 f4 }values since house prices should track incomes over the
& d# B5 A% p/ u/ ~3 L2 l, clong-run. Since homebuilders build to meet demand, we
regard housing prices and household formation as the drivers
of residential construction.
To examine the degree of overbuilding, we employ a
& e* a! O8 K9 n* |' ^“counter-factual,” asking what level of residential construction
& v( K7 g4 ~" ]( ?( j; Iwould have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
4 \7 @( G* u$ V" q7 K3 Nfundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
' H( @+ g/ b- m$ Owhere housing demand will further contract under waning
population 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
  e9 k  ^7 e4 Mhas been relatively balanced but, while not plagued by structural
" J# O: G, D( }  D1 tweakness, will be singed by the downturn nonetheless.
9 J3 Q: ]" m6 y4 f4 J3 f+ M7 @- [6 c6 hQuébec shows signs of strain – especially given the
# d; @# u9 d- P% d! 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
rates. While Ontario homebuilding will reel from a
. h# P; e, }( R* N1 v( M4 P1 E( `cyclical downturn, the degree of structural weakness appears
$ w) z" }1 G2 k: {' t, slimited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
+ _/ V$ h. C6 `, G+ Sconstruction mean that record numbers of condos will
0 m# n7 `: s* I2 @. preach completion during 2009. If absorption rates fall, as
' e( L% @- E6 P" d3 a  g  ecyclical factors would indicate, condo inventories could
" d, P) {! \6 N: l$ ^" Q2 ~spike severely – particularly in Vancouver. However, while
residential construction in B.C. will definitely droop, we
5 y/ h5 w  u+ l9 X* Fanticipate that the West Coast will continue to benefit from
6 s$ @0 @" i7 Q" k) Ninter-provincial and international migration over the coming
years, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
4 a" z1 L) ~9 P2 s) i$ g# \OVERPRICED AND OVERBUILT: CANADIAN HOUSING
! Q9 d) e2 j3 J* Y' k1 ~MARKET RETURNS TO FUNDAMENTALS
0 g6 ?8 k, v, N! ]' g( o$ ?4 X  J' lGrant Bishop, Economist
416-982-8063
1 _. B: U, `* q) tPascal Gauthier, Economist
416-944-5730

9 \% d# a! A. e% P8 N) K& k# Q) a. ehttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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