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
0 m$ B. q' {  P" D& e# }6 |unsustainable levels of building. Our view is that house
. v' o1 ~& d( x) j6 Mprices exceeded the value of housing that was justified by
8 R# m" L# C( S1 L1 C. Y& vfundamentals by approximately 9% nationwide. This
" ]" S3 M( I) P# d. V7 K- j% A* w, Eoverpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
, b* I  X) H9 ]; S12%, an excess that was exaggerated in the past
4 p. }* P; a8 G# V' W. uthree years.
" M' G& H" `$ b; CBy “overpricing” we mean that prices detached from
8 {4 l- |% d" ]  z0 J2 ~6 k0 D9 Qtheir fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
2 U  S% D$ x6 Y0 _0 tboth a cyclical downturn and a return of house prices
( i5 u, j" t* E$ D. }' u  pto fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
2 B3 f1 G( x; F3 G8 Z5 kwhere homebuyers buy up too many houses and
, ^+ E' @' @5 _4 {: c$ P3 Cthat this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
1 U, O0 {* Y& N9 kthere is evidence of both types, we contend that Canada’s
2 g5 l/ u! Q  c5 W  }“overbuilding” was mainly of the first type, where
" z1 a. d3 ~# n" Q  Qhomebuyers pushed homebuilding to an unsustainable pitch
5 T; B7 n8 i" A+ h5 q. Gthat is now being rapidly reined in.
  S) G9 @% a8 Y5 s4 Z$ N2 p8 O* G& VWhile most markets won’t face U.S.-style overhangs,
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
; a% J" F6 J9 e4 D$ N1 {4 [2 \from the cyclical downturn, house price growth will
remain choppy and new residential construction will be
8 I, m5 T3 V- a/ N9 mdampened, owing to this structural weakness. Construction
- f, d+ {) l( N, ]3 Nis now undershooting fundamentals and we expect this
to 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
in the fourth quarter.
4 G! B& j" R' \5 b1 `7 ?$ f% ITo quantify the degree of overpricing and overbuilding,
) W, B4 C% v4 f  l3 M: t3 Xwe 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
values since house prices should track incomes over the
long-run. Since homebuilders build to meet demand, we
regard housing prices and household formation as the drivers
of residential construction.
+ l5 G$ R- ?/ z: ~To examine the degree of overbuilding, we employ a
, l: l8 u3 b% I$ w' M$ |5 u/ x“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
+ M3 M( ]; l1 K& K0 v6 W+ koptimally. We find that actual homebuilding exceeded this
: I1 p( W. e9 P& k- ?fundamental-justified level by about 12%. Although new
units 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
3 a" ~6 p; V) y$ {8 }* Mpopulation inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
& W% s( G8 J# w- Xvery time that the resale market has swung into strong
buyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
9 l# A; i; _6 @) a( L- j5 J2 s: nweakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
) _" _. E$ D; T) V1 r1 O, e% _- bstrange accumulation of unabsorbed multiples on l’Île de
0 F0 D; r( e. n/ v9 MMontréal – but recent building has been relatively balanced,
1 w& e) X  E: \given the province’s history of under-building and low ownership
/ l9 b+ y% L6 N, r4 Zrates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
' _' b3 U9 u7 t& v# flimited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
construction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
! g. Y) v* h0 `, n0 z0 t9 lcyclical factors would indicate, condo inventories could
7 I: e# T# V* Q1 d! D1 ?  \spike severely – particularly in Vancouver. However, while
: x: V0 q; J) C  C2 Tresidential construction in B.C. will definitely droop, we
anticipate that the West Coast will continue to benefit from
" w% `0 ~; ~$ W% a# jinter-provincial and international migration over the coming
" y7 N7 h/ n. w7 Syears, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
$ c: h. R9 l/ H) aOVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
1 ]$ S' j" }/ _  n/ }Pascal Gauthier, Economist
416-944-5730
( O0 Q- \/ P' y+ e3 ~( |6 i+ P
http://www.td.com/economics/special/gb0409_housing_exec.pdf

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