TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
% B" S9 F: C4 zfrom 2002 to 2008, unsustainable price increases drove
6 E8 I$ |0 e0 M& G# c% hunsustainable levels of building. Our view is that house
3 ?. L9 C. m6 u. O" \: `0 Iprices exceeded the value of housing that was justified by
0 h4 b8 M" O' R9 \% ]fundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
0 t+ t6 z3 S! T* U6 c7 Gthat exceeded its fundamental-justified level by approximately
! h$ C6 T. ]" X) e' A( a12%, an excess that was exaggerated in the past
. \" O* v/ I: b0 R1 S: s2 Pthree years.
By “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
6 K, E3 d3 Z, G7 b* Faffordability. The current unwinding of house prices reflects
both a cyclical downturn and a return of house prices
to fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
4 `2 }+ q; ]+ p  lwhere homebuyers buy up too many houses and
$ r/ k/ g7 k. ?* sthat 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
! P2 A2 z  @- Q- d. G“overbuilding” was mainly of the first type, where
$ `- M) X8 G. Q) \, S: shomebuyers pushed homebuilding to an unsustainable pitch
# Z& L7 w, h9 n4 y* I  I! dthat is now being rapidly reined in.
! ]: F+ P. y& w& ^8 oWhile most markets won’t face U.S.-style overhangs,
the construction of too many new homes over the boom
- C, b/ A; ~4 e6 Y; Tmeans a deepened slump. This overbuilding will likely weigh
; D: P' N- T) Z* C9 K4 Ron markets over the next few years. Even as Canada recovers
7 W7 V* j% ~! U6 I8 b- Yfrom the cyclical downturn, house price growth will
' ]3 D# t' i2 d8 z' [* tremain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
0 n) d/ N1 ^" U+ p8 V6 ito persist over 2009 to 2011. We anticipate that nationwide
residential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
# s4 M1 G& z; k$ ~in the fourth quarter.
; \2 H8 n* x5 MTo 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
province. Affordability is the key concept behind home
" F+ j6 {" I# O. D$ K. r( Svalues since house prices should track incomes over the
long-run. Since homebuilders build to meet demand, we
( S2 L8 y' m: C6 x7 o  hregard housing prices and household formation as the drivers
of residential construction.
, q1 y# T9 B' B+ v2 N+ p  l+ q$ h4 }To examine the degree of overbuilding, we employ a
! p9 F6 R) Y6 z“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
7 C, [) G  M5 f8 Z& @/ N' Xoptimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
: Z' {8 `  }( ?: z$ cunits were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
7 K) x+ e# F: SRegionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
& c9 i( R; e; M& d# p" [+ |7 Npopulation 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
( T5 I8 ^( s9 G1 r7 b: r: Chas 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
8 b/ C7 f. D+ \9 W3 ?Montréal – but recent building has been relatively balanced,
. w2 L' H2 t; x2 O  |- I3 S5 vgiven the province’s history of under-building and low ownership
/ L) m8 ?- c1 @rates. While Ontario homebuilding will reel from a
' w  V4 x$ k& W4 j* Wcyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
+ I4 L7 @: G7 H1 v2 icondo market. Both in Toronto and Vancouver, historically
8 o  `$ h+ V8 B. Chigh levels of apartment-style units presently under
construction mean that record numbers of condos will
; E+ k) e4 S. j8 |, F# p1 Xreach completion during 2009. If absorption rates fall, as
( Q1 y7 z+ C$ |6 H% zcyclical factors would indicate, condo inventories could
) j, R2 J5 v; D# w' ~+ xspike severely – particularly in Vancouver. However, while
7 A; y0 G6 N1 y9 ^4 h8 J" C* Q. Gresidential 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,
will alleviate some of the pressure from overbuilding.
  k! a3 z. P( }9 v+ o: Y8 NOVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
% k& {, Y" r4 V( {" D+ zGrant Bishop, Economist
416-982-8063
Pascal Gauthier, Economist
416-944-5730
& f$ n! v9 h3 @8 [
http://www.td.com/economics/special/gb0409_housing_exec.pdf

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