TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
& x! R9 B! ^: o: F! I2 Yfrom 2002 to 2008, unsustainable price increases drove
8 P7 w  G" \) k1 D$ x6 cunsustainable levels of building. Our view is that house
prices exceeded the value of housing that was justified by
5 `  _& r) h8 E" J1 X8 kfundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
, W- T0 V% o7 T1 ythat exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
three years.
By “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
! d6 L" k$ l5 e- a2 t$ ]affordability. The current unwinding of house prices reflects
! r% v1 ?4 x$ |both a cyclical downturn and a return of house prices
to fundamentally justified levels.
" r5 t9 m  t% F4 HWe 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
9 W9 E) O" h1 Xthere is evidence of both types, we contend that Canada’s
- T* m& Z+ M- \2 Z9 T! O* w“overbuilding” was mainly of the first type, where
0 k8 e8 \1 A9 H# h8 Q* Ghomebuyers pushed homebuilding to an unsustainable pitch
! n& p  t& n! Z4 V% t; x. w2 sthat 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
means a deepened slump. This overbuilding will likely weigh
; `' N) `; L+ j# K+ H, k' zon markets over the next few years. Even as Canada recovers
; K; F" G+ `- X3 _( p) [from the cyclical downturn, house price growth will
3 K% [/ ?$ U3 |8 u& `, x9 M. B! lremain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
- Q" c6 U0 Q6 }5 T: dresidential construction will fall further to around
! C7 t  c5 Y+ D" U% |8 a! B125,000 starts over 2009 with a trough around 115,000 units
  N# G# `' O, S5 I) Vin the fourth quarter.
To quantify the degree of overpricing and overbuilding,
3 x3 `4 e# p& H1 d, O/ K! g7 |- zwe first develop an empirical model, based on long-run
, w& u) S' w- l7 xfundamentals of house prices and housing starts in each
7 Z. e4 Z; c3 [0 ^& mprovince. Affordability is the key concept behind home
* B) H( v% B$ ]  P# x  Q8 O4 Pvalues since house prices should track incomes over the
long-run. Since homebuilders build to meet demand, we
) A2 K# q. h( ^5 v9 ~4 N+ M! hregard housing prices and household formation as the drivers
of residential construction.
4 P9 q7 b% f& X$ A% KTo examine the degree of overbuilding, we employ a
' b1 P8 {2 _8 L% \“counter-factual,” asking what level of residential construction
4 ?  ]; Z+ V: ?1 S" Xwould have occurred if housing had been priced
4 D9 i% B2 W* h9 w; ^; P8 h+ uoptimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
* F* F! z6 |, B4 k2 Q* Yunits were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
" [7 k# S$ x- I3 ?+ ?% Q" i+ VRegionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
. Z# d0 [; y% p9 @# b; }, E1 Yalready witnessing surges in their unsold new homes at the
very time that the resale market has swung into strong
+ n& C% X: y' X) z9 r  P4 Z% ~buyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
6 ^5 m  s- C* H6 r7 D) b6 gweakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
2 q' {) |1 a. _$ k. R5 y4 s6 dstrange accumulation of unabsorbed multiples on l’Île de
Montréal – but recent building has been relatively balanced,
; E" `0 ^& l3 y6 u+ I! Vgiven the province’s history of under-building and low ownership
rates. While Ontario homebuilding will reel from a
4 ?! D: f. _/ K  c- R4 f3 Rcyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
0 `) L( T3 ^5 |* rcondo market. Both in Toronto and Vancouver, historically
! V& f& J9 l# dhigh levels of apartment-style units presently under
construction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
+ G( H( m6 H% Z4 Ecyclical factors would indicate, condo inventories could
2 v' s0 R5 e" d* L) \4 x1 D6 e( `: Rspike severely – particularly in Vancouver. However, while
3 }4 R  @4 X& o1 P3 U7 @residential construction in B.C. will definitely droop, we
anticipate that the West Coast will continue to benefit from
; S. T8 `7 V+ t: s1 {* \inter-provincial and international migration over the coming
5 {3 G& t; \# e* [4 X- x& Ryears, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
; @  B7 ^1 G- U$ iMARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
+ h; t  _3 W3 E& |. TPascal Gauthier, Economist
416-944-5730

# G  h. h  l2 A8 [; _http://www.td.com/economics/special/gb0409_housing_exec.pdf

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