TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
! r, l- D; L( c- `from 2002 to 2008, unsustainable price increases drove
unsustainable levels of building. Our view is that house
! ?: O; w3 }( K8 K1 P& Eprices exceeded the value of housing that was justified by
. X( H: ~. x! i4 g/ W8 O$ Dfundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
$ v: p: H6 Y. _+ j1 |8 N0 Qthat exceeded its fundamental-justified level by approximately
) V5 W$ U& h7 u) k12%, an excess that was exaggerated in the past
8 @- n; {( [" Cthree years.
By “overpricing” we mean that prices detached from
! j+ C* ~) w7 X- C& I5 A$ f$ wtheir fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
; o7 r) O1 j' k; V0 s; R/ O8 M: X4 pboth a cyclical downturn and a return of house prices
4 O* u+ [5 S( M. \" b; [to fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
6 [& ]+ d' E! o! W/ X- Xwhere homebuyers buy up too many houses and
: ~: _/ t6 I8 \  u( K' w  @that this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
9 a; [/ g4 \7 N8 f1 l7 athere is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
+ O+ q/ X3 `0 Y2 othat 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
+ P& o7 n1 q$ O8 p+ y. B: ]" i9 Lmeans a deepened slump. This overbuilding will likely weigh
# O. V$ {9 f/ i9 L9 y' D" uon markets over the next few years. Even as Canada recovers
from the cyclical downturn, house price growth will
3 x  H8 l9 j& e) mremain choppy and new residential construction will be
8 K1 q# N) z/ Q) Z4 u, \dampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
4 r1 x$ ^, x) V  V- dto persist over 2009 to 2011. We anticipate that nationwide
, C+ I2 ^! D% w7 xresidential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
  \7 |4 a  N. F. j% p7 i" qin the fourth quarter.
To quantify the degree of overpricing and overbuilding,
we 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
2 r" ]9 |; z: R6 [7 {% @& \4 Y% H! ovalues since house prices should track incomes over the
long-run. Since homebuilders build to meet demand, we
0 V2 D' k) a. ~7 v% f/ fregard housing prices and household formation as the drivers
of residential construction.
To examine the degree of overbuilding, we employ a
; q7 P# ?+ S& F" r“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
! s# ^3 Z5 ]0 |/ f. b, P7 @! Uoptimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
+ _/ D: Z  M3 s# o# `units were being absorbed, homebuyers simply bought too
, b! O+ ?; o' ~/ {$ V$ t. Umany houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
! |0 f1 A( A4 w5 ~* R2 Y; jvery time that the resale market has swung into strong
buyers’ territory. Homebuilding in the Atlantic provinces
9 g; K* D( d0 n; Z/ N5 M7 zhas been relatively balanced but, while not plagued by structural
weakness, will be singed by the downturn nonetheless.
* `( o5 V% B& ^' z3 F, r  ^Québec shows signs of strain – especially given the
" K0 h# T! X8 _! b" f' [$ M" {strange accumulation of unabsorbed multiples on l’Île de
) V8 n& Q4 q/ EMontréal – but recent building has been relatively balanced,
given the province’s history of under-building and low ownership
; w0 [7 i" s* a1 p. urates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
9 z" m* D# f9 M# {- Z# R& ucondo market. Both in Toronto and Vancouver, historically
4 i9 M) y) M$ K* [! n1 ~high levels of apartment-style units presently under
  G# h+ L6 O5 l7 J" p( _construction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
- l1 N  W$ W! W+ r* Bcyclical factors would indicate, condo inventories could
9 g* u% ?- H8 V1 c% ^spike severely – particularly in Vancouver. However, while
( g# A& M  D) k1 X; ^7 N2 aresidential construction in B.C. will definitely droop, we
0 [2 d7 ?$ C5 L6 t! d, Ganticipate that the West Coast will continue to benefit from
inter-provincial and international migration over the coming
  g) ~" |$ ]4 P) N) Jyears, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
- T; t7 A, W1 [  C. V* q$ iOVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
Pascal Gauthier, Economist
416-944-5730

5 J. }& ~" [' F3 `3 }) @7 p8 fhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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