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
prices exceeded the value of housing that was justified by
' W; {# S6 N9 ~  n/ m) Vfundamentals by approximately 9% nationwide. This
4 m0 X) S, R/ t# y, v" d$ aoverpricing compelled a level of residential construction
( b: Y& c& W! b4 c4 H; Q, d' E" wthat exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
three years.
4 H, e8 ?% k" D. }By “overpricing” we mean that prices detached from
: p/ [& Q: X, z2 ztheir fundamentals, as witnessed by a steep erosion of
' n9 V# Q" w/ `) Taffordability. 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”
! ^$ P& G4 z! z5 y: j1 Cwhere homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
% A) Q6 b8 M7 @1 l5 lwhere builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
) G" {0 U/ [2 V5 G) U' bhomebuyers pushed homebuilding to an unsustainable pitch
' K, [; t) z& s$ xthat is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
the construction of too many new homes over the boom
3 z1 C. ?4 }! Omeans a deepened slump. This overbuilding will likely weigh
) }, s. Z, f; \( a  V# o8 pon markets over the next few years. Even as Canada recovers
from the cyclical downturn, house price growth will
3 B" J. q8 W5 ?9 ?8 i) Mremain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
) J) f% i$ E9 |: qis now undershooting fundamentals and we expect this
/ y. f1 Y9 f8 E( K* j3 hto 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
# d7 x6 [. |( X1 wprovince. Affordability is the key concept behind home
values since house prices should track incomes over the
) h) D* s, c7 e! l8 Y0 u% U. glong-run. Since homebuilders build to meet demand, we
regard housing prices and household formation as the drivers
4 e- \9 p- f3 Q8 gof residential construction.
To examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
would 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
; l2 s8 Y: x, Rmany houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
. d* ~8 \% c% a7 }; X5 D: N0 Awhere housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
* s) l3 I1 Q. R1 Ealready witnessing surges in their unsold new homes at the
* e0 n0 q5 e% ~6 h$ g8 Avery time that the resale market has swung into strong
& A* l/ ]1 t6 B$ p4 Q( I+ g; y( dbuyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
4 G1 ^" Q4 N% Z/ C" @, K1 f6 iweakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
+ j  Y( m1 ^/ `9 ?& Mstrange accumulation of unabsorbed multiples on l’Île de
3 C, o9 q. a6 N0 e/ v8 p1 U. ]  OMontréal – 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
% W3 m1 O* L% [+ w& k; z. xlimited – 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
" d' T3 x+ M2 E2 R/ |reach completion during 2009. If absorption rates fall, as
- M1 A$ S5 d: V: x: bcyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
9 `3 M! G9 G+ u$ r8 sresidential construction in B.C. will definitely droop, we
/ }% N0 U! _- Ianticipate that the West Coast will continue to benefit from
inter-provincial and international migration over the coming
years, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
: d0 c$ s- c1 A( \% G  B( d4 {OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
8 k0 t* \! r, o, jGrant Bishop, Economist
6 J4 y. p: p1 X' d7 [( J416-982-8063
Pascal Gauthier, Economist
- x& y$ P4 @" N* T+ J1 e6 @- x# A416-944-5730
7 G) J4 Q( R4 }  s  P
( f7 p. I+ C4 i9 fhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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