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
5 p  o- }6 N/ ?unsustainable levels of building. Our view is that house
+ v3 v* `* o3 L. d& J0 W; |8 j( {! Iprices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
1 w8 o8 H5 T) p) ?& {% Ithat exceeded its fundamental-justified level by approximately
2 u* g$ r8 _$ A6 G12%, an excess that was exaggerated in the past
three years.
By “overpricing” we mean that prices detached from
( E/ i+ d  a# b; K: t& m* v0 n4 Etheir fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
+ x9 |4 t5 M: E2 p8 g* E& {both a cyclical downturn and a return of house prices
7 e' @1 k) o2 h3 u& s4 p" [to fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
8 g5 R% }; b1 @; _where homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
% A7 ]$ _( |2 ?, n“overbuilding” was mainly of the first type, where
3 m3 \, r8 y1 u" Khomebuyers pushed homebuilding to an unsustainable pitch
8 _0 ?; x. M  Z7 othat is now being rapidly reined in.
2 K+ j) \; \; g7 p7 wWhile 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
) r$ O- @1 W5 b' b4 ron markets over the next few years. Even as Canada recovers
from the cyclical downturn, house price growth will
9 m$ X3 ]" L3 p8 N2 f3 P) cremain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
, [# n" l" c* k! Y" e. Y7 m- G6 dis now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
" T. h/ Q% g; o8 U- Dresidential construction will fall further to around
+ N' |3 p; e; P3 }8 D125,000 starts over 2009 with a trough around 115,000 units
, d2 t1 x. ~7 u2 ], win the fourth quarter.
/ C" j, y! a, M" ]6 g) zTo 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
. M6 q' C1 W: p  V/ X2 R+ P+ q" yprovince. Affordability is the key concept behind home
: Z4 g; G) l" n% b5 \2 n' Yvalues since house prices should track incomes over the
long-run. Since homebuilders build to meet demand, we
; o& ]9 @. Y! D4 ^/ h- H! M  ~; dregard housing prices and household formation as the drivers
5 u, `9 X- Q" Z6 N4 j& Iof residential construction.
/ L% d1 N5 a6 n& U; H; wTo examine the degree of overbuilding, we employ a
4 i, `0 O+ d/ ~* L3 W8 l  J) @“counter-factual,” asking what level of residential construction
3 f5 k1 Q2 k3 X8 }8 `$ Zwould have occurred if housing had been priced
2 U, _3 w+ k* v! Aoptimally. We find that actual homebuilding exceeded this
) |0 l3 l7 |- G# M0 qfundamental-justified level by about 12%. Although new
9 W2 T2 ]- w6 ^4 m1 Vunits were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
& l8 y& Z5 s/ Z$ T, u6 Z1 dwhere housing demand will further contract under waning
% k* S$ V7 h% F$ [population inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
, r6 p0 M$ W9 c" P0 ]( R4 nvery time that the resale market has swung into strong
) \: `3 U3 [+ k/ b* D* r3 Kbuyers’ territory. Homebuilding in the Atlantic provinces
has 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
strange accumulation of unabsorbed multiples on l’Île de
Montréal – but recent building has been relatively balanced,
1 E2 n4 {$ n8 y& t, O% j0 egiven the province’s history of under-building and low ownership
- x! ?; B/ W2 y) nrates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
' i1 \! n. c5 _& O, o  B' J( s0 Slimited – with the important exception of the Toronto
' N" @" W' N) A& N& f3 X. 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
2 h2 Q6 G& D8 ^cyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
& ~% W: K9 k* J2 j) c6 presidential construction in B.C. will definitely droop, we
anticipate that the West Coast will continue to benefit from
0 ~5 X7 c6 h, f5 sinter-provincial and international migration over the coming
years, which, along with improvements in affordability,
% `6 F5 M, ]% O( O1 Z/ y+ Jwill alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
3 s# P7 F5 t1 }/ z, a) P2 z- VMARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
Pascal Gauthier, Economist
416-944-5730

  \1 ]2 f" y6 \6 @) Whttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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