TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
6 v7 @. H! w8 E+ s" q- `3 _3 ifrom 2002 to 2008, unsustainable price increases drove
unsustainable levels of building. Our view is that house
: z$ F- V3 v4 fprices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
that 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
; p) q$ [% Z$ ^' Utheir fundamentals, as witnessed by a steep erosion of
8 C# _" Z1 y2 ?! P3 Paffordability. The current unwinding of house prices reflects
both a cyclical downturn and a return of house prices
to fundamentally justified levels.
3 l! K3 x1 p) |. T! z  yWe consider “overbuilding” of two forms: “demanddriven”
* l- B8 o- B+ j4 _where homebuyers buy up too many houses and
  e' S: |/ h, X% J/ A& lthat this demand cannot be sustained; and “supply-driven”
6 x1 ]+ A; R6 J( a" u9 [& v3 awhere builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
8 R5 k3 J4 d+ Mhomebuyers pushed homebuilding to an unsustainable pitch
  r8 f* W/ t% S+ _  F2 i% hthat 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
, g/ E' R# O2 y0 O! B& T+ A, d! i* b# tmeans a deepened slump. This overbuilding will likely weigh
3 W# a" o7 {8 x# `4 Mon markets over the next few years. Even as Canada recovers
' e8 l0 l4 Z; f; ]- V5 c% @from the cyclical downturn, house price growth will
remain choppy and new residential construction will be
- Y; m" O* `. E( s, x: S6 }; idampened, owing to this structural weakness. Construction
2 ]& n$ P4 ?" s0 Ais now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
residential construction will fall further to around
" c3 |- ^4 I5 M125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
To quantify the degree of overpricing and overbuilding,
- n" M, r: ]5 H6 x7 hwe first develop an empirical model, based on long-run
fundamentals of house prices and housing starts in each
province. Affordability is the key concept behind home
4 V" `) x& L( b7 p" i% cvalues 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
" G4 H" d" r+ ?8 vof residential construction.
3 b- M% W2 k- L- UTo examine the degree of overbuilding, we employ a
6 ]7 x$ ?2 J4 B4 Y" u: N% ^; x“counter-factual,” asking what level of residential construction
& _( d  c8 h# z- J* ^' Y6 Wwould have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
" Q; x- F8 E/ }3 _5 R# @) L  yfundamental-justified level by about 12%. Although new
8 V1 d* D/ u2 xunits were being absorbed, homebuyers simply bought too
: N9 u  g; [& C, a) ]many houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
' y$ R9 A/ f- V& Q0 awhere housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
very time that the resale market has swung into strong
3 z6 [9 ?# i& h" g/ y' A, y; A" n2 vbuyers’ territory. Homebuilding in the Atlantic provinces
; P1 H" H3 N" T6 yhas 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
4 D3 Y$ p& r" C9 j$ bstrange accumulation of unabsorbed multiples on l’Île de
8 m+ u9 L0 |4 P2 h" u6 n$ ?Montréal – but recent building has been relatively balanced,
given the province’s history of under-building and low ownership
% p1 B! R9 z7 `4 a6 }rates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
, i# W0 ]* v( S" g5 ?3 |condo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
construction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
5 M7 U$ z( X* i7 O/ f; ecyclical factors would indicate, condo inventories could
0 O4 h0 {9 G9 k; I9 M3 \/ w/ ^spike severely – particularly in Vancouver. However, while
) b! _% K6 R  i, u3 a' f. ^residential construction in B.C. will definitely droop, we
- b  G. C8 W: e" q5 R" qanticipate that the West Coast will continue to benefit from
! p9 T! |5 f+ L# A3 S" Finter-provincial and international migration over the coming
years, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
/ C' f/ n2 B0 fOVERPRICED AND OVERBUILT: CANADIAN HOUSING
  [+ I! X$ v% x7 Q! [- [, bMARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
1 s) K. I8 P/ ?% jPascal Gauthier, Economist
' F/ j& Q" M4 J( X# [  ^9 S' A416-944-5730
; c" T" @: F5 [8 ^
http://www.td.com/economics/special/gb0409_housing_exec.pdf

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