TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
  r: H4 o# Y  ~$ o, F- cfrom 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
: R! D7 G- E5 }% pfundamentals by approximately 9% nationwide. This
+ S) v/ k! w7 H" f( O. @' h- Soverpricing compelled a level of residential construction
( ?2 P9 W; b( s5 W1 N/ xthat exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
# S& |$ S+ s% A0 p/ {6 {three years.
By “overpricing” we mean that prices detached from
  @% s5 F" g  e; {4 j+ O7 Gtheir fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
both a cyclical downturn and a return of house prices
to fundamentally justified levels.
9 `8 v3 t7 ~; h7 b, R0 yWe consider “overbuilding” of two forms: “demanddriven”
% G5 B: K$ B8 |9 g/ a2 @, swhere homebuyers buy up too many houses and
  F. b6 I) d' d1 n7 Y6 sthat this demand cannot be sustained; and “supply-driven”
; J/ T6 c, @4 t7 awhere builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
4 W: c2 ?9 j$ e" Rhomebuyers pushed homebuilding to an unsustainable pitch
$ S+ H: D; E8 n. rthat is now being rapidly reined in.
* A+ p0 G: N+ o% f8 L% ]  LWhile most markets won’t face U.S.-style overhangs,
the construction of too many new homes over the boom
# m# F; s* w* B% pmeans a deepened slump. This overbuilding will likely weigh
  _7 r" s# F2 t  w* Zon markets over the next few years. Even as Canada recovers
from the cyclical downturn, house price growth will
3 f. q9 k) E; l: M+ W' m3 c& aremain choppy and new residential construction will be
) w" M2 c$ i4 Zdampened, owing to this structural weakness. Construction
$ _2 f+ Y3 \7 s! |. Dis now undershooting fundamentals and we expect this
; j0 j2 h$ e4 L! V" n6 Mto persist over 2009 to 2011. We anticipate that nationwide
! s$ \$ ]# ~# e9 i. s8 }) L( ]residential construction will fall further to around
* r, F4 D  }  ~. G( g" N125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
To quantify the degree of overpricing and overbuilding,
; p- B% h, M! Lwe first develop an empirical model, based on long-run
5 y- ~+ m! [  q% J6 x) ^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
, y2 V  L$ D$ jof residential construction.
To examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
8 g+ D* |4 i0 Z3 swould have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
. L5 c  r; A) Q& S3 cmany houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
+ m) Q8 X' L+ @, @  j! Qpopulation inflows. Saskatoon, Calgary and Edmonton are
/ ?- P2 ]% ^: @* T  l, nalready witnessing surges in their unsold new homes at the
very time that the resale market has swung into strong
% j6 e9 M6 q3 X2 L2 [8 D/ Hbuyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
; t2 P8 @* l  Iweakness, will be singed by the downturn nonetheless.
; S; ]7 Q+ W$ PQuébec shows signs of strain – especially given the
* O7 |) z+ o3 [/ @strange accumulation of unabsorbed multiples on l’Île de
Montréal – but recent building has been relatively balanced,
$ X6 y4 A+ E. [2 W- \5 Bgiven the province’s history of under-building and low ownership
rates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
limited – 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
cyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
" Q& r+ S! O) n6 k$ [# Uresidential construction in B.C. will definitely droop, we
0 q* v3 i/ X% Z- Y* X* santicipate that the West Coast will continue to benefit from
inter-provincial and international migration over the coming
# {! v# f$ f: H" i" \: d) eyears, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
$ u5 \8 j5 S% e: a0 J# `3 k5 zOVERPRICED AND OVERBUILT: CANADIAN HOUSING
! k' c2 @7 G1 _0 [5 eMARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
4 B! @6 P  _' i0 u2 sPascal Gauthier, Economist
416-944-5730
8 c! `* C' a, m+ H2 r* a& P
5 M4 |! r  @3 \( P" j  u& ]0 K, a& Xhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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