TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
" x* Q  @& T/ O6 X$ _$ ifrom 2002 to 2008, unsustainable price increases drove
unsustainable levels of building. Our view is that house
4 E  y1 @, K* Y5 [prices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
# G9 ~# x/ o1 A+ s8 K! o/ moverpricing compelled a level of residential construction
8 r7 F4 M' ], s4 q' t3 tthat exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
three years.
9 y) D( U( N# A" A7 O5 G+ o6 {By “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
2 o% t5 h5 W# uaffordability. The current unwinding of house prices reflects
7 [. k7 f) m( l1 @4 h; Nboth a cyclical downturn and a return of house prices
to fundamentally justified levels.
# F* C6 S  g. H  V) MWe consider “overbuilding” of two forms: “demanddriven”
- }& q: }# S( {, H8 Dwhere homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
2 u9 Z' x- U6 ?+ B& Zwhere builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
6 ^5 Z+ l! |8 S“overbuilding” was mainly of the first type, where
- x* q& t) R# t0 i" G6 O' Y4 Ehomebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
9 t0 h, N3 Z& Rthe construction of too many new homes over the boom
5 w2 K( T) m' o5 t6 v1 I$ [  lmeans a deepened slump. This overbuilding will likely weigh
9 q0 H1 X  Q! r  k0 f% uon markets over the next few years. Even as Canada recovers
from the cyclical downturn, house price growth will
remain choppy and new residential construction will be
+ R6 p. a- v6 i  ^! b& n* {dampened, owing to this structural weakness. Construction
7 P+ o: n9 p8 z7 g8 Lis now undershooting fundamentals and we expect this
) y2 f5 r( F  l9 J, ?) oto persist over 2009 to 2011. We anticipate that nationwide
, W. J  R" F1 E$ l5 ~- Gresidential construction will fall further to around
3 E' S& A, i" l. p125,000 starts over 2009 with a trough around 115,000 units
$ o, v2 s/ ~/ y% ^  w  ein the fourth quarter.
# _% o# d6 U  y6 C; i8 kTo 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
province. Affordability is the key concept behind home
, ~2 N% @3 [: v$ M  ]$ d) vvalues since house prices should track incomes over the
& l" t/ b" N- |9 s' flong-run. Since homebuilders build to meet demand, we
regard housing prices and household formation as the drivers
/ j- I$ J3 d3 D  O0 I3 Tof residential construction.
' l8 N) n- B9 T% i$ ~To examine the degree of overbuilding, we employ a
2 q; M# q- q7 f2 C1 E: I- D“counter-factual,” asking what level of residential construction
7 S4 n8 L) a. O* ^1 L9 Ewould have occurred if housing had been priced
( B6 U& i/ @5 Y$ n* Woptimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
+ j* U3 n" j9 ?. imany houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
+ O: C; p% h' K6 i" _) J' d4 b7 ]2 Hwhere housing demand will further contract under waning
% J" u5 ~- F2 R5 e) x* ~population inflows. Saskatoon, Calgary and Edmonton are
! ]6 ^8 b" z  xalready witnessing surges in their unsold new homes at the
very time that the resale market has swung into strong
9 e# }6 X1 O0 b% L4 {& Fbuyers’ territory. Homebuilding in the Atlantic provinces
( {3 w! G/ V9 i6 S1 z8 ^% Ahas been relatively balanced but, while not plagued by structural
weakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
4 W" q( F0 n% }0 i' u; E9 vstrange 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
5 H. w: W" E; B" j) G' c7 a2 Krates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
! J& V4 E; N; g& r# S( C) V$ W4 J" tlimited – with the important exception of the Toronto
+ _0 s; t) _8 i  g- h9 wcondo market. Both in Toronto and Vancouver, historically
0 a. `+ N( Z- Q' Fhigh levels of apartment-style units presently under
construction 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
6 p- ~( U  W/ Z) j& A- Z9 Presidential construction in B.C. will definitely droop, we
0 N9 q7 J) _$ K+ J! a& P$ U7 Kanticipate that the West Coast will continue to benefit from
6 m) q: L; H. }/ Iinter-provincial and international migration over the coming
, W  s! G0 H/ Y9 ?years, which, along with improvements in affordability,
9 w( I2 p6 p* w3 rwill alleviate some of the pressure from overbuilding.
( C2 Q" A. s9 X0 ^3 T( DOVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
+ S5 v) l/ D- d4 ^4 O* P" t416-982-8063
& E2 {2 p$ \6 @2 \) D4 y7 o$ wPascal Gauthier, Economist
" o/ @$ j# x/ i' ^0 b416-944-5730

9 D. {: p/ \/ l/ ~3 Shttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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