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
/ v3 V% _& y# J# }# @prices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
' i& z' {" n, x! Foverpricing compelled a level of residential construction
3 L# ^) m0 |' A* g# vthat exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
three years.
# X4 j7 G0 e9 Z- C4 z7 E: SBy “overpricing” we mean that prices detached from
: D/ p0 |4 ?7 Htheir fundamentals, as witnessed by a steep erosion of
. D8 D$ ^  S1 u1 }- A3 Eaffordability. 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”
9 i' {! B/ ~4 S* [+ [2 T5 n; v- \( bwhere homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
; g  N  C4 v6 ywhere builders accumulate excessive inventories. Although
2 m. g6 X1 P  c4 @there is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
6 X! z- l2 c: D6 d5 Khomebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
2 o+ t, `+ H( t1 O; p" uWhile most markets won’t face U.S.-style overhangs,
$ N1 I- p- l% E# [! M' Athe construction of too many new homes over the boom
means a deepened slump. This overbuilding will likely weigh
+ C( M5 }$ B# V" Qon markets over the next few years. Even as Canada recovers
from the cyclical downturn, house price growth will
3 I. m* L+ i/ g' o$ n4 v* x  }7 \# Kremain choppy and new residential construction will be
% g  u9 v4 W4 i! I; j6 {& s+ }2 |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
residential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
To quantify the degree of overpricing and overbuilding,
we first develop an empirical model, based on long-run
! t3 M$ g' C% l+ U5 Sfundamentals of house prices and housing starts in each
province. Affordability is the key concept behind home
, h0 p/ E! l9 z; t& Evalues since house prices should track incomes over the
long-run. Since homebuilders build to meet demand, we
& F+ e" k' Z. U( F; rregard housing prices and household formation as the drivers
% [, I2 G1 _& dof residential construction.
) P! s, F' h6 [To examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
( h! [4 i4 d- M4 E$ t0 Jwould have occurred if housing had been priced
1 f9 o2 x/ `& b/ T+ \optimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
+ g. J& J- [5 f& c4 n& Q+ Iunits 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
- y& A3 U" d1 j; B- dpopulation inflows. Saskatoon, Calgary and Edmonton are
- x9 O& [! W  @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$ h; k8 d1 }) q8 Ihas been relatively balanced but, while not plagued by structural
5 f. z0 a9 E% q$ N+ jweakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
strange accumulation of unabsorbed multiples on l’Île de
& }! C* H9 N7 w" Q* ?5 RMontréal – 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
; H6 C; ]- E8 H2 w$ kcyclical downturn, the degree of structural weakness appears
% I- x6 ~& y- W& F) A- j% Xlimited – with the important exception of the Toronto
9 `4 j* Y. v7 k/ U1 icondo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
construction mean that record numbers of condos will
6 Z) N: ^6 D, U; D9 ^: Greach completion during 2009. If absorption rates fall, as
- @0 B0 V' y& A& Kcyclical factors would indicate, condo inventories could
2 Z' D7 a' S- T4 Zspike severely – particularly in Vancouver. However, while
* q8 r0 ^1 }, L: |4 j6 c0 H" 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
2 y& m/ O. T0 Z1 Hyears, which, along with improvements in affordability,
. V; e+ w+ O' [, r  y# uwill alleviate some of the pressure from overbuilding.
4 l9 P- W0 F, [5 n1 Q' GOVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
; N# p: N3 j. m  r$ {416-982-8063
! @7 P; B% l+ F) g8 e( i$ rPascal Gauthier, Economist
3 s0 H9 V: \  d416-944-5730

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

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