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
0 C7 Z. _' B" t9 Bunsustainable levels of building. Our view is that house
9 j' b- o" ~% _$ ~0 c1 L1 v/ Cprices exceeded the value of housing that was justified by
* |/ w* c* ]" o) b6 A( {fundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
1 Z. P0 u! O3 W1 O5 d: Y) H" jthat exceeded its fundamental-justified level by approximately
5 r3 M) Q/ H: I) S( n12%, an excess that was exaggerated in the past
/ K. v4 G) S: U/ B2 V# Ythree years.
By “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
/ Z9 ~! n3 F1 R# J% aaffordability. 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”
' c) F  _- w; C/ g2 a/ v! Rwhere homebuyers buy up too many houses and
7 c: Q6 A: u7 s1 E9 S8 S/ zthat this demand cannot be sustained; and “supply-driven”
  a7 |& c$ l  l2 @/ c6 Y$ H% @where builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
' Q# U8 b5 _9 b1 B* V1 J& Fhomebuyers pushed homebuilding to an unsustainable pitch
( A& x2 R$ O" G% f6 a" wthat is now being rapidly reined in.
/ h* S0 Q4 y: x! {While most markets won’t face U.S.-style overhangs,
the construction of too many new homes over the boom
means a deepened slump. This overbuilding will likely weigh
3 j6 }. V" D( S) B3 n" _& con 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
dampened, owing to this structural weakness. Construction
0 W- J* ^1 m! `/ Nis now undershooting fundamentals and we expect this
7 a  W- @  o" m0 M) Bto persist over 2009 to 2011. We anticipate that nationwide
4 I4 Y% e8 Z0 f6 J' J' lresidential construction will fall further to around
+ O+ |6 p5 G, s$ s' |125,000 starts over 2009 with a trough around 115,000 units
' H) _: d% g: c& U8 u& R* O+ d& lin the fourth quarter.
7 C% b; l( o; r8 }: uTo quantify the degree of overpricing and overbuilding,
2 U$ l( Y  F3 u8 [6 w  Qwe first develop an empirical model, based on long-run
+ ]0 a* {+ n( m- K' X/ a; R/ Gfundamentals of house prices and housing starts in each
* B) y3 f# V7 J/ L9 w( R, p% jprovince. 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
of residential construction.
To examine the degree of overbuilding, we employ a
, G; A2 I9 Y) v9 i) ?: W“counter-factual,” asking what level of residential construction
' g* j- w) n4 E% }# lwould have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
  p$ `' ~% q* ?fundamental-justified level by about 12%. Although new
4 Y1 M, F1 h& ]( E; _! ?units were being absorbed, homebuyers simply bought too
1 }) o" \2 T1 d7 M9 Z- s1 C) A0 Wmany houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
0 k/ K5 k2 C0 W5 W4 Q( c3 h! fwhere housing demand will further contract under waning
0 W+ l, H9 K  F* l( Qpopulation inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
' v; b: n7 k+ h& ~2 mvery time that the resale market has swung into strong
buyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
0 f3 j  R. Q: A9 L9 z0 N$ \7 Iweakness, will be singed by the downturn nonetheless.
) j' J' {  \1 I# v  s9 XQuébec shows signs of strain – especially given the
: t) ~9 ^& `$ w* c9 j9 l( o% tstrange accumulation of unabsorbed multiples on l’Île de
& }& s1 M4 s5 O/ P4 z  M5 {4 J' gMontréal – but recent building has been relatively balanced,
8 X$ ?) t: v! ~given the province’s history of under-building and low ownership
- f# }0 L' x/ |rates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
  k1 c- g: \" [' Kcondo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
2 c; `! ^( w9 w' D- Y, cconstruction mean that record numbers of condos will
8 k& O0 |8 f0 e4 w/ y6 [reach completion during 2009. If absorption rates fall, as
9 `* S/ W" T0 @  t" dcyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
; b7 {5 I2 n2 d  H7 uresidential construction in B.C. will definitely droop, we
* {5 V4 ?6 N0 o: Danticipate that the West Coast will continue to benefit from
2 }& d8 M  O8 Yinter-provincial and international migration over the coming
+ d4 p" y# v4 G/ R: Y0 Lyears, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
3 f$ \( N; Q. C* n3 D# ^Grant Bishop, Economist
416-982-8063
Pascal Gauthier, Economist
416-944-5730
4 n% X; Q1 {5 d* g6 a! Q- \
6 `) \+ k. E( {& Y* p$ Nhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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