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
, a( H1 I/ [( G, G7 J/ m; c; W4 kunsustainable levels of building. Our view is that house
& {' d( d' f& }' w# pprices exceeded the value of housing that was justified by
( |9 d" I6 j+ p8 i, ^9 ~fundamentals by approximately 9% nationwide. This
4 R. w1 h( @4 m8 k# x' zoverpricing compelled a level of residential construction
0 _4 }+ h7 ?: y7 n  F2 u+ vthat exceeded its fundamental-justified level by approximately
& G5 ]. P( n8 g9 W( l1 e12%, an excess that was exaggerated in the past
three years.
By “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
2 R& S7 ^9 \3 z# k6 {" E1 vboth a cyclical downturn and a return of house prices
to fundamentally justified levels.
- V6 M2 W! J; A% i% oWe consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
! }" S6 K9 t& ^. W$ Othere 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
4 W' F$ t7 m- |that is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
) k  w. j2 P% J8 Y& B: ethe construction of too many new homes over the boom
! N( p% ?. E7 ^4 H/ D' Fmeans a deepened slump. This overbuilding will likely weigh
on markets over the next few years. Even as Canada recovers
! P) D9 M4 Z& t& |: g' h" Z: c7 |from the cyclical downturn, house price growth will
# b5 B. l! b3 i$ kremain 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
; `5 a( l& `+ {0 R5 u+ Q8 _residential construction will fall further to around
& z! e$ ?. C) ?0 {125,000 starts over 2009 with a trough around 115,000 units
! Z3 i( \0 g& h& ?# Pin the fourth quarter.
To quantify the degree of overpricing and overbuilding,
we first develop an empirical model, based on long-run
! V6 X& c0 W* l7 ?1 n$ ]fundamentals of house prices and housing starts in each
province. Affordability is the key concept behind home
1 Q+ s" X3 Z+ W' [values since house prices should track incomes over the
6 s/ p7 t0 P- ?long-run. Since homebuilders build to meet demand, we
6 Z8 l. u" W3 Sregard housing prices and household formation as the drivers
of residential construction.
To examine the degree of overbuilding, we employ a
" D4 z3 B9 d+ _# y* \“counter-factual,” asking what level of residential construction
  p2 B1 c2 W" a, u  S2 }7 }" uwould have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
: w* c) p( k" z) E$ _. K2 Sfundamental-justified level by about 12%. Although new
; `6 S6 f& r, n) P7 Dunits were being absorbed, homebuyers simply bought too
% X0 V% ^- S! ?: b, Cmany houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
# Q+ }. w" |( g( A3 ~8 Zwhere housing demand will further contract under waning
3 z5 B  Z" T/ I2 G$ z1 i) zpopulation inflows. Saskatoon, Calgary and Edmonton are
* }3 |. F# z& A0 S, u  balready 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
) }$ X' i0 j7 i, D4 d9 }) J* Vhas been relatively balanced but, while not plagued by structural
7 D: ?- d0 g  e* f3 [+ iweakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
" x; }7 Z+ Y# i# 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
rates. While Ontario homebuilding will reel from a
* b* o! w) }/ Q' v8 F. |4 scyclical downturn, the degree of structural weakness appears
8 s) [' H6 N, rlimited – with the important exception of the Toronto
. Y, k2 w2 @. D: q- W8 v2 w# o" Ucondo market. Both in Toronto and Vancouver, historically
+ C3 D. t" r8 t6 k; T7 Z( ^! ]high levels of apartment-style units presently under
* e% z: M3 m& E; A/ B$ r+ ?0 `% ]construction mean that record numbers of condos will
( Z- p$ M% U$ e, |3 Ureach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
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
7 ?+ r5 J6 w8 lyears, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
& t# _7 r5 @# L9 BOVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
% Y  b/ R3 A4 ZGrant Bishop, Economist
416-982-8063
; E" ]4 g9 X) L' I* V) }: |Pascal Gauthier, Economist
416-944-5730

1 M7 z* d* c* @http://www.td.com/economics/special/gb0409_housing_exec.pdf

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