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
unsustainable levels of building. Our view is that house
( [' M' u- s+ p: iprices exceeded the value of housing that was justified by
. x# z' |9 \+ M( v0 m: A* [% Afundamentals by approximately 9% nationwide. This
/ Z  _& D8 ?8 O2 o( loverpricing compelled a level of residential construction
: K1 s/ W- x7 i) vthat exceeded its fundamental-justified level by approximately
2 V! W# g- w1 q& P) c& A+ ^12%, an excess that was exaggerated in the past
three years.
( S4 }# `4 O/ h' U/ c3 m, ZBy “overpricing” we mean that prices detached from
4 N& W  x6 O: k* ~$ [their fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
both a cyclical downturn and a return of house prices
to fundamentally justified levels.
' h" H4 q5 r1 x. K0 R* n8 ?We consider “overbuilding” of two forms: “demanddriven”
* ^6 f) m" B- d  q/ A2 bwhere homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
. _! W% A- [0 ]0 x1 _where builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
9 K1 b" {7 G* ~$ `# V$ b: u# r“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
: D0 H* L. u* ?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
1 K% g7 }- i+ e- G" {& dfrom the cyclical downturn, house price growth will
+ I' d4 G# K: x( V$ Hremain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
% O3 L& E- R$ f, z8 I/ |* {is now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
residential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
To quantify the degree of overpricing and overbuilding,
5 Q5 Y3 j# `* g6 t1 m0 Xwe first develop an empirical model, based on long-run
$ [3 T+ m0 K! ~6 _/ G) W( wfundamentals of house prices and housing starts in each
* S- f3 A- E! q% X4 iprovince. 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
' D/ j5 Z$ v  Z( V3 jregard housing prices and household formation as the drivers
of residential construction.
To examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
: U; z; U3 U( j/ l  {units were being absorbed, homebuyers simply bought too
: B. S7 O. B$ |3 W' Y: P  k$ g2 s8 ~many houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
3 A3 A: o: R* w2 x6 S/ }population inflows. Saskatoon, Calgary and Edmonton are
) q2 ^, _$ Y. F7 ]already witnessing surges in their unsold new homes at the
very time that the resale market has swung into strong
; d+ y! W  y5 a- W3 |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.
Québec shows signs of strain – especially given the
0 }! h9 B" l+ u% K& t7 [# }strange accumulation of unabsorbed multiples on l’Île de
- h# X0 k1 \3 h) X* nMontréal – but recent building has been relatively balanced,
. X) i8 ?/ [- b+ Sgiven the province’s history of under-building and low ownership
rates. While Ontario homebuilding will reel from a
0 }' M3 W7 @: A$ t4 dcyclical downturn, the degree of structural weakness appears
limited – with the important exception of the Toronto
8 P+ m9 o  f' s, a* ycondo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
9 _+ S$ b9 Q& w0 W3 b1 S9 mconstruction mean that record numbers of condos will
( ^( t  U# q- n0 breach 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
' R' y1 K0 f' E. Y# t( h- canticipate that the West Coast will continue to benefit from
; Y, o6 {4 E( sinter-provincial and international migration over the coming
0 L/ Z) L  K9 `# \/ D$ @years, which, along with improvements in affordability,
2 d$ B, s9 {, `! S" w: ]will alleviate some of the pressure from overbuilding.
* I0 P" x8 K2 e0 MOVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
# f" _& U$ H  Q5 _  x4 D) fGrant Bishop, Economist
416-982-8063
( d" R" K% L$ q& _, WPascal Gauthier, Economist
416-944-5730
' e2 h  y( o/ [+ b  e" e+ l. }
2 y) j2 A1 o( D/ s5 uhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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