TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
9 X3 S) Y) q, l' ?8 dfrom 2002 to 2008, unsustainable price increases drove
unsustainable levels of building. Our view is that house
' ?, G% o% B' L3 b* f( O. Iprices 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
3 S. `, [! t. j8 l12%, an excess that was exaggerated in the past
three years.
By “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
( U. U" a1 D1 P+ E5 baffordability. 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”
5 U4 I' o% M4 U* i% q( dwhere homebuyers buy up too many houses and
$ C2 K( a0 B, h2 P7 Wthat this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
* x, e. X5 l& v5 ]1 @* j+ othere is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
. L8 ~. {  w2 v2 M+ _homebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
3 w: p9 C* u9 e" z& ZWhile most markets won’t face U.S.-style overhangs,
$ v4 V( H# A4 z6 W5 c; Y6 Gthe 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 k- f$ e1 Y8 G/ d+ lfrom the cyclical downturn, house price growth will
4 T) B6 ]1 b# Qremain choppy and new residential construction will be
% \$ W3 C' h" g: pdampened, owing to this structural weakness. Construction
' y- F6 Q- O; R& ^& k$ o8 Ais now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
1 P+ b- b  p9 bresidential construction will fall further to around
; y3 ^" [% i, _  \9 L" g125,000 starts over 2009 with a trough around 115,000 units
2 j: k; K1 o+ P* R/ Min the fourth quarter.
To quantify the degree of overpricing and overbuilding,
% x! Y2 F9 s3 U6 Y8 e0 `we first develop an empirical model, based on long-run
4 B( v( s& ~2 D. N7 e% i- ffundamentals of house prices and housing starts in each
province. 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
0 |3 I4 I2 L# k' @. y& x2 ?of residential construction.
3 m+ e. `5 @  V+ m! YTo examine the degree of overbuilding, we employ a
( w8 p& U* |! d7 I( \“counter-factual,” asking what level of residential construction
3 j6 m% ]  v" n/ H9 \% J. q$ M6 gwould have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
/ a* V  v8 f7 h5 ~fundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
/ |4 `5 ?! L, Q; k2 V/ r, n/ r0 z( xRegionally, we see the greatest strains on the Prairies,
1 k" q% ?% \) E  Rwhere housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
! X8 f  f( m) z; W5 _9 falready witnessing surges in their unsold new homes at the
: V3 c* P: P. K. ?, R% xvery 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
0 U2 n" F! w3 q. t7 {) vweakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
strange accumulation of unabsorbed multiples on l’Île de
Montréal – but recent building has been relatively balanced,
, y0 {, a2 l- sgiven 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
* y/ P+ @/ T% g0 h/ ~4 Wlimited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
, p: F+ l% G& `+ m: j* lhigh levels of apartment-style units presently under
; U1 i. A) ^* b. D8 v9 a$ `  Y6 {8 C& jconstruction mean that record numbers of condos will
- K7 _% C/ ^! X  ~7 A  O) ireach completion during 2009. If absorption rates fall, as
2 ?- o7 W' N: N- C# [- Ucyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
residential construction in B.C. will definitely droop, we
anticipate that the West Coast will continue to benefit from
inter-provincial and international migration over the coming
years, which, along with improvements in affordability,
- ?  V; s& w, P6 W" r. v3 v4 Cwill alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
( _, ?1 U  l+ S# rGrant Bishop, Economist
416-982-8063
Pascal Gauthier, Economist
! H  }! l) K3 o4 E416-944-5730
, o) m: T0 c$ k% Y  {% B# ]& |
& ^' q0 o# Y) D) V, q/ Thttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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