TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
$ P4 R* R3 x: A5 w+ J8 afrom 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
fundamentals by approximately 9% nationwide. This
" }1 T! Y+ S1 j' J- Qoverpricing compelled a level of residential construction
9 K9 C  ]' ^, B) |$ |# Z8 pthat 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
  O; B1 q; ~8 s* Rtheir fundamentals, as witnessed by a steep erosion of
$ d* p: V  Y' O* R2 {+ T, m& |affordability. The current unwinding of house prices reflects
both a cyclical downturn and a return of house prices
to fundamentally justified levels.
. p' G5 y$ N) SWe consider “overbuilding” of two forms: “demanddriven”
6 d9 }6 }6 W7 |0 o7 Ywhere homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
3 ~4 s% y4 t, ?: l! Ewhere builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
3 d1 X! Y. ~+ l4 _While most markets won’t face U.S.-style overhangs,
" `' X) M. e* S$ n7 E7 B% u( X6 [the 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
  q9 t- h. v# @, Q: G" L8 _9 Efrom the cyclical downturn, house price growth will
, q. u1 b( w" A+ {9 O. ?4 U1 @remain choppy and new residential construction will be
8 b# r/ d" C# Z& @( L' edampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
+ u* Q' z" v* L* y  {/ ato 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
4 O" m" D4 a* o3 kin the fourth quarter.
To quantify the degree of overpricing and overbuilding,
7 J$ L  [  \; L4 s& ?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
) s0 \6 g+ E* {6 K# @values since house prices should track incomes over the
: A2 \7 t. B9 q7 x" xlong-run. Since homebuilders build to meet demand, we
3 o5 f. ~8 V" B" cregard housing prices and household formation as the drivers
of residential construction.
7 H# h0 b% n* B% _To examine the degree of overbuilding, we employ a
) c% [6 J2 Z- w8 p; `! A“counter-factual,” asking what level of residential construction
: t: g: Y: w  Y8 U7 K2 P! x8 [8 Cwould have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
; @9 a5 p2 `8 Dfundamental-justified level by about 12%. Although new
- Q4 W; a( c; Q  v! i4 Junits were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
: H$ R/ |0 p4 T6 |2 ]population 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
  W+ P/ Y" t" F  \; h5 z- {0 a) Nhas been relatively balanced but, while not plagued by structural
weakness, will be singed by the downturn nonetheless.
! F* c$ w) o1 x" e+ kQuébec shows signs of strain – especially given the
strange accumulation of unabsorbed multiples on l’Île de
. q2 @3 m+ K& QMontréal – but recent building has been relatively balanced,
, O$ b1 x" T8 Q9 Bgiven the province’s history of under-building and low ownership
rates. While Ontario homebuilding will reel from a
5 A/ J0 @: y  K0 V2 A* Icyclical downturn, the degree of structural weakness appears
: N9 R, e/ Z  v7 ^) y- S& i' y# L: klimited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
/ Y" z( r; n4 S! ^high levels of apartment-style units presently under
! s2 y9 a- c7 y+ U8 n& K" Xconstruction mean that record numbers of condos will
! i7 O. g& A$ F$ Ereach completion during 2009. If absorption rates fall, as
7 ?& x' W. F9 h; _) Q9 j& X* N$ Hcyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
& ?9 t8 Y+ h* m7 S( mresidential construction in B.C. will definitely droop, we
anticipate that the West Coast will continue to benefit from
& N# B9 r+ Z6 ?) Zinter-provincial and international migration over the coming
; B/ O9 i  _  {, V- C$ [) dyears, which, along with improvements in affordability,
) f+ X7 Z) T+ a6 Y2 G5 e% [will alleviate some of the pressure from overbuilding.
- v* ]' Z2 `" V! i; g& G& @! bOVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
) m0 U  W) G7 B1 u! DGrant Bishop, Economist
416-982-8063
+ U' @& e8 q7 x6 S8 Q- Z; x+ fPascal Gauthier, Economist
416-944-5730

http://www.td.com/economics/special/gb0409_housing_exec.pdf

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