TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
) Z3 O7 O5 \3 X& w" q( \5 W: tfrom 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
2 ?' E# Y' T, H1 p+ v/ o' cfundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
( G8 o3 ], b9 @; a( _0 Q0 A12%, an excess that was exaggerated in the past
: i& x# c. `" @/ N: Sthree years.
By “overpricing” we mean that prices detached from
/ B. e) T' s% D. Ttheir fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
. y3 I" i  h( |" {) }/ k1 P+ W/ t' Nboth a cyclical downturn and a return of house prices
to fundamentally justified levels.
( ~  J+ e. Y4 o' N8 }- Y* I% LWe consider “overbuilding” of two forms: “demanddriven”
/ P* [8 b# I* s4 l" ]( x4 L; Swhere homebuyers buy up too many houses and
: E& B% p2 ^& t, m4 g+ Rthat 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
“overbuilding” was mainly of the first type, where
  ~* P" W, M* p* F5 u: ?homebuyers pushed homebuilding to an unsustainable pitch
6 {5 c0 y7 Q; I7 j8 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
means a deepened slump. This overbuilding will likely weigh
on markets over the next few years. Even as Canada recovers
6 L. z( O9 G+ x( J- O0 hfrom the cyclical downturn, house price growth will
( e+ B4 ~0 i  n  S9 ]3 a' J  L8 `' mremain choppy and new residential construction will be
' k! g" l9 [9 \. @$ t1 @3 pdampened, owing to this structural weakness. Construction
% S6 s* T- N8 |2 w+ i+ H5 U/ C$ Qis now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
' i3 P4 n) O' D9 @residential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
/ i0 V1 U+ H' K$ Y% Q1 qin the fourth quarter.
To quantify the degree of overpricing and overbuilding,
we first develop an empirical model, based on long-run
/ N1 d6 C, l* r0 [, \) B+ Gfundamentals of house prices and housing starts in each
. y& g9 [; m: C& Hprovince. 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
) J( x+ G! k; J1 b) c( o" {1 Aof residential construction.
' n! G5 d" r* V" e( e) B: s" h7 wTo examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
) O1 _, @( E% t" o/ ]$ v8 |would have occurred if housing had been priced
5 g5 m  v/ ~2 M) z7 o; A9 E. _optimally. We find that actual homebuilding exceeded this
/ G6 \; K" N0 a, q; W; r4 Yfundamental-justified level by about 12%. Although new
  [$ a! E; ^# ^' iunits were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
% V3 }4 t2 Y* Q- t$ N  nRegionally, we see the greatest strains on the Prairies,
  D# y0 _  ~% r% |& ^/ \" n. hwhere housing demand will further contract under waning
) c' Q5 o+ Y5 j8 ^0 zpopulation inflows. Saskatoon, Calgary and Edmonton are
+ m/ [3 c8 z( X. n$ C" h  ]already witnessing surges in their unsold new homes at the
very time that the resale market has swung into strong
buyers’ territory. Homebuilding in the Atlantic provinces
% e! Y/ {% V2 x: G" ohas been relatively balanced but, while not plagued by structural
weakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
9 G  c" T, N9 e% m- gstrange accumulation of unabsorbed multiples on l’Île de
# O) F6 ?% C8 B5 ?) P0 u0 X5 ~' TMontréal – but recent building has been relatively balanced,
8 ^& \6 D/ O/ H2 ?# v1 g! p' Ygiven 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
condo market. Both in Toronto and Vancouver, historically
% _2 f. |# P  u" ~1 Chigh levels of apartment-style units presently under
0 ^0 d# a, z0 F7 |- D4 Pconstruction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
7 j: {+ |$ C6 `0 mcyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
, o& k$ R# u# z5 w$ }9 a/ dresidential construction in B.C. will definitely droop, we
2 W/ N3 Y. |% r6 K8 M9 o3 b/ A; M/ eanticipate that the West Coast will continue to benefit from
7 Q8 E6 t9 |$ X7 b& t5 Kinter-provincial and international migration over the coming
7 c- K0 b9 E0 [( lyears, which, along with improvements in affordability,
% A3 D  o7 S. L7 v; n+ J' u, }# Hwill alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
$ T8 F3 d1 k+ {; _MARKET RETURNS TO FUNDAMENTALS
+ a+ K" `1 d1 F  u) j2 L1 ]Grant Bishop, Economist
416-982-8063
: C: V! E1 r# v5 t# n' \Pascal Gauthier, Economist
416-944-5730
. {0 x& b1 b* {4 j9 F- C* Q% i
/ |1 b5 T! t% C* X# dhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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