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
2 i* W3 M% \; g' d& s/ bfundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
0 k  u3 z4 V! j* G: T/ F& _* X12%, an excess that was exaggerated in the past
: }' T$ ]! n) b  |three years.
By “overpricing” we mean that prices detached from
/ r* Y, r' `- k5 A3 Z4 btheir fundamentals, as witnessed by a steep erosion of
; K! k0 }  n( ^4 \7 s  taffordability. The current unwinding of house prices reflects
; x6 u" l, D7 O& y8 d% Kboth a cyclical downturn and a return of house prices
# w$ O6 V: q& c! D! Yto fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
- a) w, {8 s, Z7 ywhere 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
5 b( k( p4 }) C; U2 _/ P“overbuilding” was mainly of the first type, where
" Q! M7 f9 p: F& W8 jhomebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
3 f( G4 Y/ x* T! N' A( c6 d6 oWhile most markets won’t face U.S.-style overhangs,
. C) B" r  G6 Rthe construction of too many new homes over the boom
+ z; Q$ g/ Y  t# i, Imeans a deepened slump. This overbuilding will likely weigh
on markets over the next few years. Even as Canada recovers
from the cyclical downturn, house price growth will
/ r$ r$ @, w! N4 ~9 s; t: l  c8 Oremain choppy and new residential construction will be
7 s* h0 M( \2 c$ w5 p4 \, ?  Qdampened, owing to this structural weakness. Construction
. O5 u1 X$ c$ ?! L+ Sis now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
9 k6 k/ L0 U4 k' @. L  cresidential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
9 Z3 s" n. P( ], F& z  sTo 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
6 S* v# o% ^" ~province. Affordability is the key concept behind home
/ k- N8 ~. \2 E, L3 B8 Y- ]& xvalues since house prices should track incomes over the
long-run. Since homebuilders build to meet demand, we
* P; L' _7 u& G" i3 V$ T/ Q' Lregard housing prices and household formation as the drivers
! f* R7 L* P. c; }; b, l  ^- _of residential construction.
: q3 L: ^0 ^7 [% s( g& u5 {To examine the degree of overbuilding, we employ a
6 k  Q3 b* A" b“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
; I" y. o% m7 p3 c: X" T" B8 O, o3 Vunits were being absorbed, homebuyers simply bought too
  }& C, C: g6 |6 Rmany houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
6 R1 ^" P2 X8 L7 B  Q( Gpopulation 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
) B, e- G3 m; p5 chas been relatively balanced but, while not plagued by structural
0 j( U' W  Q+ x0 A* u' g. Zweakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
- z4 N) x" b* _3 ~7 A  X' c* Y2 [strange accumulation of unabsorbed multiples on l’Île de
Montréal – but recent building has been relatively balanced,
8 s  R# b$ u0 H& egiven the province’s history of under-building and low ownership
5 ?0 p# T! u. x/ R3 f" @rates. While Ontario homebuilding will reel from a
* |+ ^! F. z1 q& Ucyclical downturn, the degree of structural weakness appears
) k. l1 Y; _. x) f+ U8 }limited – with the important exception of the Toronto
- u/ r* g3 _: dcondo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
2 O' `. K9 W- T+ q  o, J1 wconstruction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
* M' j* g$ @8 M9 P7 M9 V$ _) bresidential construction in B.C. will definitely droop, we
anticipate that the West Coast will continue to benefit from
  }# L( G6 x; B7 `' z- }inter-provincial and international migration over the coming
" j% {, J( M  u8 t. f7 kyears, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
$ ^9 m) u7 V4 P* |  D! bOVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
- |$ e2 W; u6 P/ R+ K$ p( ?4 DGrant Bishop, Economist
416-982-8063
Pascal Gauthier, Economist
416-944-5730

3 e: h2 B1 K3 L! F9 ^http://www.td.com/economics/special/gb0409_housing_exec.pdf

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