TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
( A' D( i  c! c. Q& V3 zfrom 2002 to 2008, unsustainable price increases drove
2 M5 v3 v7 |5 U+ L1 I- \( Eunsustainable levels of building. Our view is that house
5 ~  y7 |0 l8 `prices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
; h( O4 Q6 ?; }8 j* b6 poverpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
3 c0 U3 G; |! o! Y9 lthree years.
By “overpricing” we mean that prices detached from
' L$ X4 y3 u1 Y4 T! }# w# ?! Xtheir fundamentals, as witnessed by a steep erosion of
: [  m, m& V/ i$ Oaffordability. The current unwinding of house prices reflects
both a cyclical downturn and a return of house prices
8 f( P+ B$ ^7 H1 k1 P2 Dto fundamentally justified levels.
. X& N- D7 X3 ]/ @8 A! I  GWe consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
" Z( L1 Z- A, ]there is evidence of both types, we contend that Canada’s
5 _4 ~. S* M5 F- Z! x“overbuilding” was mainly of the first type, where
) G4 f: `$ |0 G3 U4 @* F8 P7 hhomebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
. i1 ^6 U: C0 G' wWhile most markets won’t face U.S.-style overhangs,
. F! [+ `( V  N- Zthe construction of too many new homes over the boom
means a deepened slump. This overbuilding will likely weigh
% E$ X: T: l( A/ e: [on markets over the next few years. Even as Canada recovers
from the cyclical downturn, house price growth will
) t7 q+ U! R( b! @8 u" n' jremain choppy and new residential construction will be
" B* z6 y0 ^' R% S% f/ X2 Qdampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
: Q" N' |% ]; G- |+ P0 Hto persist over 2009 to 2011. We anticipate that nationwide
/ b, m$ ?3 X% D. R$ m7 ]* aresidential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
) x! x) A( ]; x! ]in the fourth quarter.
( a+ w8 {, Q6 k, p7 ]$ GTo quantify the degree of overpricing and overbuilding,
: \; e# h5 t0 O" Rwe first develop an empirical model, based on long-run
) W; E9 J9 X; ufundamentals of house prices and housing starts in each
5 O6 H9 h  z) z  qprovince. Affordability is the key concept behind home
, f5 d+ B: s" j+ E- Gvalues since house prices should track incomes over the
8 m1 n+ J, h  P2 p1 |5 m$ ylong-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
  W5 j$ L( G! ]+ ~5 f( e  ]“counter-factual,” asking what level of residential construction
7 E$ ?. \1 p2 Ywould have occurred if housing had been priced
2 j/ c: Q1 T& z$ S0 G( z& r9 xoptimally. We find that actual homebuilding exceeded this
9 s' t; u, F8 E, C+ E* ^- Xfundamental-justified level by about 12%. Although new
4 y. N) V& V9 P) \units were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
& O5 R: E' ?6 D- j2 h- ?( qRegionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
: b1 B' Z; [. _0 U, ~population inflows. Saskatoon, Calgary and Edmonton are
, b( x! t. D8 }$ halready witnessing surges in their unsold new homes at the
, D* ~5 M8 y4 v) kvery time that the resale market has swung into strong
. M, V' Z* b! Z% dbuyers’ territory. Homebuilding in the Atlantic provinces
+ n8 y! k' d# g8 s- H% {has been relatively balanced but, while not plagued by structural
3 y- o. S3 n8 x; I) C2 U! o3 nweakness, will be singed by the downturn nonetheless.
  K; c" F6 A2 mQuébec shows signs of strain – especially given the
7 p6 v+ {( i8 C* b9 Z! k, mstrange accumulation of unabsorbed multiples on l’Île de
) i5 p1 W; m* I$ LMontréal – but recent building has been relatively balanced,
given the province’s history of under-building and low ownership
( _2 q3 t, o1 [3 Q/ Irates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
' }* l. x* Y% x, ]condo market. Both in Toronto and Vancouver, historically
; H( i1 c3 }; Y7 Xhigh levels of apartment-style units presently under
" {; ~7 H$ O" k. X4 e% s% Z# C+ Nconstruction mean that record numbers of condos will
& @6 [- f1 K7 e6 ~- Ureach completion during 2009. If absorption rates fall, as
! N& k+ |. H8 b4 ucyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
residential construction in B.C. will definitely droop, we
4 b0 S8 b7 M% wanticipate that the West Coast will continue to benefit from
inter-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
MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
Pascal Gauthier, Economist
( h* m# q' U" a4 O- d416-944-5730
& z6 \. r& ~' D8 }; Z! `
" |2 ]- t% ^" C2 J/ H5 \" k" }http://www.td.com/economics/special/gb0409_housing_exec.pdf

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