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
prices exceeded the value of housing that was justified by
7 w1 d7 z( E- T3 _fundamentals by approximately 9% nationwide. This
, N! C' X* A- n; R3 u4 S  koverpricing compelled a level of residential construction
5 R; M! \! Q$ Y' Lthat exceeded its fundamental-justified level by approximately
5 c, e4 s$ O5 j/ m3 B5 h5 A12%, an excess that was exaggerated in the past
3 K7 b0 u5 f' a2 Jthree years.
By “overpricing” we mean that prices detached from
1 M7 e7 T$ A" ]4 A- \their fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
$ u* n; l' H3 B* pboth a cyclical downturn and a return of house prices
2 C9 o! U: W+ ^. ]( v& oto fundamentally justified levels.
. `5 k5 _0 C) S7 S6 a$ NWe consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
6 u& i7 e" C  Fthat this demand cannot be sustained; and “supply-driven”
' Z: I, D1 a% G. gwhere builders accumulate excessive inventories. Although
, k9 z3 K( Q* J. T" rthere is evidence of both types, we contend that Canada’s
7 F- ^5 A0 ^0 B$ _, g, C. }“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
7 Z- x% i4 f7 uthat is now being rapidly reined in.
" n: J' q! m9 k# d' `8 WWhile most markets won’t face U.S.-style overhangs,
the construction of too many new homes over the boom
; z& @* T0 T! \, \, I1 o$ F- qmeans a deepened slump. This overbuilding will likely weigh
on markets over the next few years. Even as Canada recovers
" }) N2 Z. M: g7 O6 ^from the cyclical downturn, house price growth will
remain choppy and new residential construction will be
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
! L0 z. z$ `9 `5 l, ]4 S* X125,000 starts over 2009 with a trough around 115,000 units
- l; w* C8 [  y* @8 l: Oin the fourth quarter.
To quantify the degree of overpricing and overbuilding,
. f  B8 V. H2 A' H0 b# jwe first develop an empirical model, based on long-run
; d. B0 T: x) Y; Ufundamentals of house prices and housing starts in each
province. Affordability is the key concept behind home
; @$ W  i& D% N3 Yvalues since house prices should track incomes over the
long-run. Since homebuilders build to meet demand, we
# u6 {) c4 ^- Kregard housing prices and household formation as the drivers
/ E- f3 ~2 w! _) u4 rof residential construction.
To examine the degree of overbuilding, we employ a
* i1 g6 d- B( M8 I“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
* i/ ^& o( [$ A- H8 g/ S4 Tfundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
4 v& N- K  B0 F0 wmany houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
$ P' k1 ~- L+ a+ Y# |% Zwhere housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
1 g0 C! y2 x3 {% @already witnessing surges in their unsold new homes at the
very time that the resale market has swung into strong
* R0 L. a8 R$ _* J# r/ U* @buyers’ territory. Homebuilding in the Atlantic provinces
0 D5 ?" N: b$ Z* E2 H$ ]8 nhas been relatively balanced but, while not plagued by structural
weakness, will be singed by the downturn nonetheless.
: N% P- ^6 Z% z' b6 y" g, p6 pQuébec shows signs of strain – especially given the
9 v' e6 _* Q) W8 V, M, Jstrange 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
* b% w1 {2 ^3 A0 w, b  c( H( lrates. While Ontario homebuilding will reel from a
/ J* e$ u* M+ ?7 y/ V3 F) Ocyclical downturn, the degree of structural weakness appears
/ F8 M* c1 c  D# l6 e  y8 w. hlimited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
) R  u: {' K5 o7 C0 c' g; P: W6 whigh levels of apartment-style units presently under
construction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
# ~5 c+ \& T& [. P# x+ W' {+ C+ [/ s" @spike severely – particularly in Vancouver. However, while
residential construction in B.C. will definitely droop, we
anticipate that the West Coast will continue to benefit from
inter-provincial and international migration over the coming
years, which, along with improvements in affordability,
5 j' C2 j% X8 z9 `& jwill alleviate some of the pressure from overbuilding.
: w! p1 u; h2 c. t% n9 A+ J! JOVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
9 n2 P# o1 h& ]6 @Grant Bishop, Economist
416-982-8063
Pascal Gauthier, Economist
; }" `% \$ K/ e. d) s416-944-5730

+ [; n5 {, `; P, i/ ^http://www.td.com/economics/special/gb0409_housing_exec.pdf

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