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
unsustainable levels of building. Our view is that house
prices exceeded the value of housing that was justified by
9 H' W" ^% L/ n' ^1 m8 R% Rfundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
! [+ X! Z9 o8 c' Ethat exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
1 I/ J; r% [2 Mthree years.
By “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
; K2 v/ f  `2 Yaffordability. The current unwinding of house prices reflects
! }: S. M( t8 Y( ]+ \both a cyclical downturn and a return of house prices
% v% {) T, u( I. _( T+ K# Tto fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
. _/ V. A" M% Z3 E7 s0 Fwhere homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
( t$ G7 P6 X: ^& ?. jwhere builders accumulate excessive inventories. Although
/ v7 H8 }9 Y( S6 ^1 @, Ythere is evidence of both types, we contend that Canada’s
/ F; _! R# c; Y/ R“overbuilding” was mainly of the first type, where
/ _8 s9 b6 O3 G1 C- T5 jhomebuyers pushed homebuilding to an unsustainable pitch
, x: l  R, i) B" ^  ?that is now being rapidly reined in.
+ _3 r5 s/ F  A, oWhile 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
1 Y& e% S& ?$ D. i0 d7 Rfrom the cyclical downturn, house price growth will
6 T4 c- Q  o( T. I! m+ G2 Qremain choppy and new residential construction will be
5 v7 B" l# q/ K" Y: X' u7 `& Tdampened, owing to this structural weakness. Construction
. E: K; t/ o- C/ j0 ?4 Zis now undershooting fundamentals and we expect this
; Q, A+ m( J; Z* m0 Nto persist over 2009 to 2011. We anticipate that nationwide
residential construction will fall further to around
2 ]& y# z1 r) |& ]125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
+ a- J. k% S& m7 n5 H, wTo quantify the degree of overpricing and overbuilding,
we first develop an empirical model, based on long-run
2 v8 C! L6 h( e+ L5 b% H% N) N. \, Vfundamentals of house prices and housing starts in each
0 e$ ~4 z: `, W0 mprovince. Affordability is the key concept behind home
values since house prices should track incomes over the
0 y6 U' {2 @8 N  rlong-run. Since homebuilders build to meet demand, we
% [* Q) J3 `7 ^regard housing prices and household formation as the drivers
of residential construction.
% P5 I! P+ [: S) @' {To examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
/ G# ?$ C1 h6 p% N$ L8 cwould have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
. `) q& |* {; L8 Y5 @many houses at prices that exceeded fundamentals.
. n: v0 g( s1 ?Regionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
/ v) a" _% n% l. b( `9 _* B( lpopulation inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
% `# Q7 Z; }) M( ]4 Hvery 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
weakness, will be singed by the downturn nonetheless.
5 m# {1 A- T+ O2 s4 {4 z6 i- \: k  ZQuébec shows signs of strain – especially given the
+ E+ z% b4 |* Y, B: ]3 M( ^strange accumulation of unabsorbed multiples on l’Île de
: ~7 B% E3 L8 T: |Montréal – but recent building has been relatively balanced,
3 N* w3 S& [+ |8 K) c& zgiven the province’s history of under-building and low ownership
) |* y1 I& O9 t$ B5 Grates. While Ontario homebuilding will reel from a
. r/ t3 u9 D- \1 pcyclical downturn, the degree of structural weakness appears
- X+ h. h. G7 \- [3 climited – with the important exception of the Toronto
$ \7 i4 O% W4 y& fcondo market. Both in Toronto and Vancouver, historically
; C: o8 `( [1 c5 n" G, P5 rhigh levels of apartment-style units presently under
construction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
: f2 i- X0 K2 o$ hspike severely – particularly in Vancouver. However, while
5 h& i/ ?5 l" b; q4 d" sresidential construction in B.C. will definitely droop, we
' K8 n* M! P$ s/ P* M1 ganticipate that the West Coast will continue to benefit from
$ A) O7 g' s# g8 k: o' Kinter-provincial and international migration over the coming
years, which, along with improvements in affordability,
% Q% Y0 r! z# \) Gwill alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
. V! ~' ^, B$ r" w: P+ BGrant Bishop, Economist
416-982-8063
7 W1 K+ g) N6 I6 {& aPascal Gauthier, Economist
416-944-5730

http://www.td.com/economics/special/gb0409_housing_exec.pdf

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