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
2 T( c; ~% v1 B6 ~* g7 Y+ e% [unsustainable levels of building. Our view is that house
& l3 m7 Z7 R) C7 b+ r: \prices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
- w% h( |) n7 \overpricing compelled a level of residential construction
9 ^5 p8 X0 n' U9 dthat exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
" I0 Y! r& l" X% T6 z' l- `. ythree years.
3 p1 I5 t$ L) \; tBy “overpricing” we mean that prices detached from
their 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
to 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
0 i! ]" L3 F. s- K( O4 W! u“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,
+ `  f; x+ w( f+ T; A# |( _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
7 Y7 n/ h6 }% j  V# zfrom the cyclical downturn, house price growth will
remain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
" }' z. z9 z" A) ]is now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
( w( e  F# d% `2 i5 ^5 P- oresidential construction will fall further to around
' r9 U' V  |$ g( w125,000 starts over 2009 with a trough around 115,000 units
1 K) X3 o% }) Ain the fourth quarter.
, R  x& I; Q  ZTo quantify the degree of overpricing and overbuilding,
we first develop an empirical model, based on long-run
; ?0 H- c2 Y( d8 jfundamentals of house prices and housing starts in each
province. Affordability is the key concept behind home
4 o; C- B  t. }7 Y* a$ i2 f) Svalues 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
7 r- H3 w3 ~$ }5 h“counter-factual,” asking what level of residential construction
' [/ W; j/ s' v! K7 Pwould have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
( f6 F3 t" W( ofundamental-justified level by about 12%. Although new
) W0 z2 E" j5 P+ j3 R% u7 Bunits were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
/ L+ M: v- \% V0 r: n4 z) rRegionally, we see the greatest strains on the Prairies,
7 Q' x6 p& y) ?# G2 A0 \. Swhere housing demand will further contract under waning
: j3 }/ t5 m; q3 }0 Q+ jpopulation inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
( n8 A0 [. U* Q. k- Tvery time that the resale market has swung into strong
& I, F5 k8 ~9 A* _7 t/ dbuyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
4 i6 K3 L! k) J0 U! k  Iweakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
strange accumulation of unabsorbed multiples on l’Île de
* I, T6 L& l" XMontréal – but recent building has been relatively balanced,
0 J* N1 e! `2 d2 z( C5 w' F% hgiven the province’s history of under-building and low ownership
rates. While Ontario homebuilding will reel from a
6 A0 r# V% G: ^6 y8 L% C7 B& m$ Ecyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
" j% P; X6 S" V% f, g" ?condo market. Both in Toronto and Vancouver, historically
. N/ g- B* l+ G4 phigh levels of apartment-style units presently under
construction mean that record numbers of condos will
) O+ m6 N4 F% L, p. }" ^reach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
; w" f( X- o3 k9 t4 N# k0 @+ [residential construction in B.C. will definitely droop, we
/ T/ g1 D* S6 P; v+ Xanticipate that the West Coast will continue to benefit from
inter-provincial and international migration over the coming
2 T( ^1 x: R8 C8 r2 O* ^0 ayears, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
9 r6 g! D6 i+ EGrant Bishop, Economist
416-982-8063
$ M: p( U9 M% g! o. GPascal Gauthier, Economist
5 r" u( ?1 h7 d4 @" k) B416-944-5730
/ a$ Q+ d7 \& N: T+ c: w$ i
5 |7 _6 X  Y2 Ohttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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