TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
$ K. N) D( d4 w6 l& l! Vfrom 2002 to 2008, unsustainable price increases drove
unsustainable levels of building. Our view is that house
- d) J$ o* Z  m, q! b! \prices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
+ U( H+ [. h: z6 Loverpricing 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.
* }' n" a, d: X* D& S0 LBy “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
# D7 U) j8 w% M1 Naffordability. The current unwinding of house prices reflects
5 b: Q* O: T  U5 v5 rboth a cyclical downturn and a return of house prices
to fundamentally justified levels.
7 T: \% h3 m7 F8 N4 W  `% O$ {/ QWe consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
& M; |  T' s/ F: i: S! O( ~that this demand cannot be sustained; and “supply-driven”
" |3 m( |* y( ^! M. o* t  q0 owhere builders accumulate excessive inventories. Although
0 a7 C6 Z. e2 Y9 }8 B1 othere is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
: _. Z: v/ S: `5 H+ [% ^; whomebuyers pushed homebuilding to an unsustainable pitch
that 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
means a deepened slump. This overbuilding will likely weigh
on markets over the next few years. Even as Canada recovers
from the cyclical downturn, house price growth will
: p* ^6 y9 _5 i. y9 K1 t) vremain choppy and new residential construction will be
' S  [( {7 N1 d  K; u- v: Kdampened, owing to this structural weakness. Construction
5 W+ @1 ?+ F0 Ris now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
8 O) ^* E; f0 ?( p5 \$ |residential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
/ Y' A/ U- |, x( e+ Hin the fourth quarter.
- ]" n2 m2 {" U! v5 xTo quantify the degree of overpricing and overbuilding,
! i9 |  }0 ~0 |* |7 r& Hwe first develop an empirical model, based on long-run
+ w) N0 P3 P1 c# E  lfundamentals of house prices and housing starts in each
province. Affordability is the key concept behind home
1 y! D+ b# Y5 x8 }' M4 K/ Q, j# m1 F/ Vvalues since house prices should track incomes over the
long-run. Since homebuilders build to meet demand, we
! ^8 N& ]$ f6 mregard housing prices and household formation as the drivers
of residential construction.
! u+ k/ l- h7 u$ E0 C7 L) O. E  ETo examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
1 P# J: K! W6 ewould have occurred if housing had been priced
& A- v/ ]6 A8 l7 Loptimally. We find that actual homebuilding exceeded this
8 u/ S; A$ P& Y, g) E0 H) D# u: ?fundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
9 b! o$ D/ `% dRegionally, we see the greatest strains on the Prairies,
1 V( y" F, @0 L) R# t4 }: X2 h8 lwhere housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
+ `, d, M" @. d' @( }very time that the resale market has swung into strong
$ t& Q9 H" s; E+ r5 p7 J  i6 [: `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.
6 ^4 q% t& |8 r& e5 WQuébec shows signs of strain – especially given the
, v) s) W. q  ]0 J- ]strange accumulation of unabsorbed multiples on l’Île de
Montréal – 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
- o9 D& E+ A+ Y/ wcondo 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
cyclical factors would indicate, condo inventories could
4 ~" V9 j" `- s) V' C* D6 O& qspike severely – particularly in Vancouver. However, while
  y& l) S. r) X( k  }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
# v% J0 t2 G0 m* Gyears, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
- W$ q. B9 q4 U5 u, P, y) U416-982-8063
Pascal Gauthier, Economist
416-944-5730

8 a1 N9 F) Z6 b4 D9 O$ Thttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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