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
& I7 S6 @) d" ?7 g2 `. Munsustainable levels of building. Our view is that house
prices exceeded the value of housing that was justified by
1 J8 |; P  m$ m4 Gfundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
8 ]' B1 r1 Q, Z7 i' Q6 K6 Q6 ^6 ~6 Sthat exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
: ?4 p7 ]  F# y$ Pthree years.
By “overpricing” we mean that prices detached from
4 S% l: B1 R4 _" Ytheir 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
* D; i: M* e6 ?; e7 p( fto 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”
where builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
& ]& I7 C. U8 v3 F. e, ?: `“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
- d/ n" L; ^; s* n* e: P2 ethe construction of too many new homes over the boom
6 Q5 J3 [. e8 d: Wmeans a deepened slump. This overbuilding will likely weigh
on 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
8 r. V+ w$ |% r3 V7 idampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
/ N* X- n) @1 B6 K9 N  xto persist over 2009 to 2011. We anticipate that nationwide
. V  b3 Q/ E4 ~3 M; Q7 v  @residential construction will fall further to around
- p; ?; t# |7 N+ s8 O( F125,000 starts over 2009 with a trough around 115,000 units
  K1 f3 o1 r* {# g* g9 o/ Vin the fourth quarter.
2 z+ ?4 c0 |5 T- ]To quantify the degree of overpricing and overbuilding,
% c$ Z1 H; k5 g! I, o/ ^5 Gwe first develop an empirical model, based on long-run
2 w9 p; |, Z2 I5 y; K% \( @fundamentals of house prices and housing starts in each
% H4 V/ [) J* Rprovince. Affordability is the key concept behind home
9 x, m7 Y6 m* H( c( G, ^values since house prices should track incomes over the
long-run. Since homebuilders build to meet demand, we
/ H/ h, R0 t# T7 v: K- t0 u  Eregard housing prices and household formation as the drivers
of residential construction.
2 T% y0 J+ A) |: qTo 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
7 M$ q/ s( x4 {fundamental-justified level by about 12%. Although new
8 k( G/ W( G, ~% P' Vunits were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
0 P3 ~- V# H$ D* s  a& P& ARegionally, we see the greatest strains on the Prairies,
9 b3 y+ n% y* I1 `where housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
8 I( @$ N8 E1 R/ D6 X6 l, Ialready witnessing surges in their unsold new homes at the
+ J. F; i( l9 [. T0 k7 r* _very time that the resale market has swung into strong
( o7 X. [& @$ b  c& ?( c4 pbuyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
weakness, will be singed by the downturn nonetheless.
+ t" _) A& f8 s; rQuébec shows signs of strain – especially given the
$ y' t; w6 t8 R& w1 gstrange accumulation of unabsorbed multiples on l’Île de
# q7 R% f, _) s$ V1 x( U! 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
' p/ L/ P5 m+ w( }8 Vcyclical downturn, the degree of structural weakness appears
6 ^8 R, o0 Y8 Z3 V7 Glimited – with the important exception of the Toronto
* @* t, A" F. o8 ~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; r% U+ c$ O1 Y/ Sreach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
, q1 S% T. I# X7 H0 k, n$ w- @5 H. Mspike severely – particularly in Vancouver. However, while
% x, C9 r0 c; s5 S0 z+ mresidential construction in B.C. will definitely droop, we
, H( Q* Z7 F4 T$ e& S4 Banticipate that the West Coast will continue to benefit from
" f2 Q8 r+ c7 rinter-provincial and international migration over the coming
years, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
& i9 B/ z" M( v2 E& _" i5 ~MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
8 F& ]; C/ {5 K7 D8 N8 a) XPascal Gauthier, Economist
416-944-5730

" F$ k; Y. Z- k) qhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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