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
5 _! Z$ [$ A+ f3 runsustainable levels of building. Our view is that house
0 E  s; l( H4 L& ~2 o2 jprices exceeded the value of housing that was justified by
! O( }9 m0 T" t- Kfundamentals 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.
, c% Q& Q* c) i3 f& _+ JBy “overpricing” we mean that prices detached from
2 ?, B+ T# ~4 J+ ttheir fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
9 `1 w9 s$ `9 j6 m' Gboth a cyclical downturn and a return of house prices
to fundamentally justified levels.
; }; B4 B& q- s8 I/ ?+ Z+ KWe consider “overbuilding” of two forms: “demanddriven”
. p9 j1 m. s9 _- t+ W# b7 Bwhere homebuyers buy up too many houses and
, `  E# e9 f( ~! _1 S& i3 Y& B) }that this demand cannot be sustained; and “supply-driven”
* z$ D: b+ W; D+ B& O  Pwhere builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
# Q7 m) h" @9 Ahomebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
( h# u3 h% F6 O  {/ i) l" M) F5 Rthe construction of too many new homes over the boom
# i+ C7 d7 l1 wmeans a deepened slump. This overbuilding will likely weigh
% i5 ~# {! |( d4 P9 V0 w- aon markets over the next few years. Even as Canada recovers
from the cyclical downturn, house price growth will
remain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
, ]  S  j! N8 L2 z; hto persist over 2009 to 2011. We anticipate that nationwide
# _% h; [3 [; ]' z) b9 V$ u" U1 ^' Mresidential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
: `5 f2 I3 F  s1 j/ H( P+ min the fourth quarter.
; K# r" V" u# K" N: |) YTo quantify the degree of overpricing and overbuilding,
8 I: D' J/ Q! a& I1 s1 p" {we first develop an empirical model, based on long-run
fundamentals of house prices and housing starts in each
4 r' ]4 O) r9 J: eprovince. Affordability is the key concept behind home
values since house prices should track incomes over the
7 |: W  g8 m+ t2 \1 \* olong-run. Since homebuilders build to meet demand, we
: P9 @4 Z  j# H# Q* J$ uregard housing prices and household formation as the drivers
4 d' E, B7 P4 c0 ]% Z1 W% Aof residential construction.
6 n0 D  u9 d. d: |! ATo examine the degree of overbuilding, we employ a
3 H6 e+ `/ [$ W% q. Y“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
+ A5 Z0 k7 s0 D/ wfundamental-justified level by about 12%. Although new
6 q# g9 i/ o% yunits were being absorbed, homebuyers simply bought too
( J4 u5 M* G$ Mmany houses at prices that exceeded fundamentals.
, ^. i. {1 C2 CRegionally, we see the greatest strains on the Prairies,
3 c2 j! E; \' ~7 b) U: v" H+ cwhere housing demand will further contract under waning
9 Q+ e) T7 Z7 spopulation inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
' @- O- l6 q& ^8 g  w) Xvery time that the resale market has swung into strong
2 g0 z* _* P4 m- fbuyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
+ V  t% L& e" z& m# a& A) Hweakness, will be singed by the downturn nonetheless.
3 |* @4 n. T9 c" V  ]  I+ B2 ^0 ^# mQuébec shows signs of strain – especially given the
+ {- |" b1 L- U6 sstrange accumulation of unabsorbed multiples on l’Île de
! ^$ ^5 B# a; o' L3 z  O: e( ~3 sMontréal – but recent building has been relatively balanced,
given 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
limited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
% V% N0 I' o$ _+ Q6 {8 Dconstruction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
residential construction in B.C. will definitely droop, we
! r5 I$ X0 f: F) h" `" Y8 C# Tanticipate that the West Coast will continue to benefit from
& ]* I) h+ D( _6 Vinter-provincial and international migration over the coming
years, which, along with improvements in affordability,
. c9 w% q* [5 z. A  Lwill alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
Pascal Gauthier, Economist
416-944-5730

' g% O' Z) T$ y  x- phttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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