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
6 j6 I$ |: S1 a4 M0 Yprices exceeded the value of housing that was justified by
5 Z( U0 T- w" L, q4 z3 \+ A0 y7 Ffundamentals by approximately 9% nationwide. This
$ R* D. f9 k7 G- L! _overpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
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
2 _* ~2 P  T5 @" u3 K7 ?to fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
" R) d4 l3 h: a% Gthat 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
“overbuilding” was mainly of the first type, where
7 }2 ?- f1 W# e+ a4 [+ M; H; Z: ghomebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
6 H9 J& D" B& N( M9 w- H1 uthe 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& Y0 u2 r6 O) q0 Z/ t6 j/ Dfrom the cyclical downturn, house price growth will
remain choppy and new residential construction will be
3 h2 o7 o, c! R* G) k* bdampened, owing to this structural weakness. Construction
2 v) c8 O* M4 V1 ^7 u+ {2 Bis now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
residential construction will fall further to around
1 {& ^( T. `9 g0 D8 o125,000 starts over 2009 with a trough around 115,000 units
7 G! ]; k: B8 F7 a( A3 Rin the fourth quarter.
To quantify the degree of overpricing and overbuilding,
/ O- L. A) f$ r( ]we first develop an empirical model, based on long-run
$ B' b% c- j; \% i4 R$ i6 ffundamentals of house prices and housing starts in each
% Q, ]! R+ I, Q4 ?+ s8 b8 oprovince. Affordability is the key concept behind home
0 ?$ Z# ~- j# C! I4 cvalues since house prices should track incomes over the
- P6 l2 T& r( Ulong-run. Since homebuilders build to meet demand, we
regard housing prices and household formation as the drivers
* Y  e5 {; m; @2 z1 a0 V7 R2 z! U6 Uof residential construction.
To examine the degree of overbuilding, we employ a
* T* L, q- G- E4 e2 r3 U- w- G9 }“counter-factual,” asking what level of residential construction
' T& f( }( N% L, @! {would have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
% J8 F. l5 {7 G( w1 Eunits were being absorbed, homebuyers simply bought too
) t7 f5 Q3 x2 i. T4 @: Umany houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
2 T1 n* P" f3 w* U  Zalready witnessing surges in their unsold new homes at the
/ J% Q4 R( y) y' s: _very time that the resale market has swung into strong
buyers’ territory. Homebuilding in the Atlantic provinces
3 R. @) ^- }: _0 w; \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
+ b* }% ?$ U4 L0 e+ lMontréal – but recent building has been relatively balanced,
0 ~1 }( B( H) {. w# i- Wgiven the province’s history of under-building and low ownership
; O+ S9 }7 H$ f* m/ y( nrates. While Ontario homebuilding will reel from a
% i( T  [9 k; Y: lcyclical downturn, the degree of structural weakness appears
, b2 s! h" p* flimited – with the important exception of the Toronto
# p& K; i1 E! B0 s" scondo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
construction mean that record numbers of condos will
- d! ^7 e& ~/ c0 A5 treach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
( _# {8 r4 J5 g- i( S; L5 T5 g% @0 F3 aresidential construction in B.C. will definitely droop, we
) n  A) k, Y% V; |, _anticipate that the West Coast will continue to benefit from
2 R- }" |4 s3 B" V" q) @inter-provincial and international migration over the coming
3 |; s1 [) r6 N3 Myears, which, along with improvements in affordability,
: @  d0 H# Y1 f1 J- A0 \8 swill alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
( Z) Y& j* }* c5 FPascal Gauthier, Economist
9 @* c( x. ^* C& v8 D! O8 g" f9 X9 F416-944-5730

: m/ c  g: E! T  E* o1 @+ n; s( l& ghttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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