TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
+ Z, O% S/ r: n+ mfrom 2002 to 2008, unsustainable price increases drove
unsustainable levels of building. Our view is that house
% Y7 J6 B8 l; g/ r, }prices exceeded the value of housing that was justified by
0 |: P& u3 n) b- d2 t0 Dfundamentals by approximately 9% nationwide. This
6 P8 W6 W, l' J5 o5 s, aoverpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
- Z0 E8 U. g% S  L5 c% E/ Rthree years.
By “overpricing” we mean that prices detached from
6 A% Y" H1 e: ~6 q/ \! z. B& ntheir 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
# t- q7 K; f7 B& l; hto fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
+ a2 d$ }) `) qwhere builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
4 v( }& z  {1 D; \! j. {1 `“overbuilding” was mainly of the first type, where
4 D) a% I# h4 `+ c' U4 d4 xhomebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
* p- u0 K9 X( H, f$ f: Mthe construction of too many new homes over the boom
9 f" K) O# k. i: v; R1 J, c5 xmeans a deepened slump. This overbuilding will likely weigh
& {9 T1 ?8 d7 ?% Xon markets over the next few years. Even as Canada recovers
5 q& K# ~6 R( nfrom the cyclical downturn, house price growth will
remain choppy and new residential construction will be
" w9 _  K6 r5 D- Qdampened, owing to this structural weakness. Construction
, g! _  s0 _5 S4 f, f1 dis 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
fundamentals of house prices and housing starts in each
& U0 ?/ E  l  m, Oprovince. 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
3 ~  Z3 f; m% O' X* _! c7 A7 d9 c1 oregard housing prices and household formation as the drivers
' ^9 y, z8 _- M: s# Y4 G; _. v" Xof residential construction.
& U0 u8 D4 s* ?% n9 S) q" NTo examine the degree of overbuilding, we employ a
. R- {$ g9 ?8 ]+ L“counter-factual,” asking what level of residential construction
3 }! D' b6 A  Z# L  G6 W$ Xwould have occurred if housing had been priced
# S1 L& i  O5 y1 K6 s* ?optimally. We find that actual homebuilding exceeded this
, `' x1 a4 W- f" R' ^/ i$ W" V. Yfundamental-justified level by about 12%. Although new
" E- p6 c" V* o2 {1 M' g* Runits were being absorbed, homebuyers simply bought too
9 }, H$ ?' R! |% J8 Xmany houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
: F; E2 c/ x( U; y4 pwhere housing demand will further contract under waning
) ^5 |+ r( x$ n( Fpopulation inflows. Saskatoon, Calgary and Edmonton are
. r% z: ~1 ~. R$ \8 t8 u* galready witnessing surges in their unsold new homes at the
very time that the resale market has swung into strong
! o5 Z- ]6 ~3 {; t% ?* v$ @buyers’ territory. Homebuilding in the Atlantic provinces
  L3 d6 p, t& B' Q/ v# b: z9 E0 vhas been relatively balanced but, while not plagued by structural
' b4 q. R4 ?2 n7 _" V* q8 Tweakness, will be singed by the downturn nonetheless.
" t+ h6 t$ P& K5 p7 i. y8 ]Québec shows signs of strain – especially given the
strange accumulation of unabsorbed multiples on l’Île de
; z1 ]# ~; Q& QMontréal – 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
cyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
0 m- Z, z, R4 M+ N4 C* `" Econdo market. Both in Toronto and Vancouver, historically
% N$ L6 u) F& [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
) e+ P, v; _' N3 e/ ~* rspike 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
8 S6 l; n; L' {9 }  Minter-provincial and international migration over the coming
9 Y/ u4 |5 a6 f' \9 `7 {' h% Q7 Pyears, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
' R! e5 G4 _0 B' @MARKET RETURNS TO FUNDAMENTALS
' ]' _% T0 k- Q: m7 z, A9 [Grant Bishop, Economist
416-982-8063
6 q) d3 m3 ^% _5 CPascal Gauthier, Economist
; [6 X4 [5 ?* k# a) }: _" p1 A4 K7 X416-944-5730

8 P0 R. J. i( B% r/ hhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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