TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
6 Y, `0 n& T$ ?' U' y, s" I. hfrom 2002 to 2008, unsustainable price increases drove
/ E7 x7 i: I2 x* ?unsustainable levels of building. Our view is that house
prices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
7 Q$ c+ j4 i' D# W' H8 Vthat exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
three years.
By “overpricing” we mean that prices detached from
; o& n1 K$ o5 w4 p. r# Otheir fundamentals, as witnessed by a steep erosion of
. `( U" p* j$ m3 \affordability. The current unwinding of house prices reflects
both a cyclical downturn and a return of house prices
. O& y  {$ O3 C. eto fundamentally justified levels.
" }3 G6 @7 c% r  [We consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
/ F2 e6 H" B3 lthat this demand cannot be sustained; and “supply-driven”
2 U% I$ p8 b0 c$ x+ G9 W/ Xwhere builders accumulate excessive inventories. Although
, F& X. q' Y* _: o) Ithere is evidence of both types, we contend that Canada’s
; K3 v! I/ v0 L: ~# s$ M“overbuilding” was mainly of the first type, where
: B; Q! A7 X  x. {) xhomebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
0 ^, D# {+ t6 J; Y/ l8 ~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
' W) O- |, w9 ^2 D! Q4 Z, Jon markets over the next few years. Even as Canada recovers
& Z, L5 |; @6 ]# lfrom the cyclical downturn, house price growth will
remain choppy and new residential construction will be
1 s* v' ^2 K% q$ Z. t- ddampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
% S) g) F5 i1 Q, uto 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.
/ G5 Z# j/ M1 J, @To quantify the degree of overpricing and overbuilding,
; ?7 W5 n  `) R2 B  J8 zwe first develop an empirical model, based on long-run
  e) S6 K( r4 u6 Tfundamentals of house prices and housing starts in each
4 Y% d2 _# K; ]9 Eprovince. 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
8 ^% b. E- ?; j  R( u# F  g( M3 Kregard housing prices and household formation as the drivers
of residential construction.
To examine the degree of overbuilding, we employ a
# A4 u3 @* `: N3 D+ u“counter-factual,” asking what level of residential construction
9 i% x) a: X6 o0 f% jwould have occurred if housing had been priced
6 Q2 ]6 Q$ L* Toptimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
* m) t& c1 `0 Q( q) Y+ funits were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
) d) r8 r7 @) X$ T/ @* ~) d" hRegionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
' L+ n5 I% {; K' A- Q4 t1 malready witnessing surges in their unsold new homes at the
very time that the resale market has swung into strong
1 x* q2 e4 y0 P' E+ m- Jbuyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
& J- O# g% i+ ]! v9 {( Q: C3 V4 B5 Nweakness, will be singed by the downturn nonetheless.
% N9 {) {3 S- h2 B$ i: i' XQuébec shows signs of strain – especially given the
$ k% _+ o# Y" S+ R- Y/ Gstrange accumulation of unabsorbed multiples on l’Île de
: ^" ?5 ^& t1 `9 E& l$ H9 b# lMontréal – 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
2 L6 z% k* q5 |9 c* }! ?cyclical downturn, the degree of structural weakness appears
. f( y" z( U) `( x: ?' v/ D7 Ylimited – with the important exception of the Toronto
. W/ {( ?" U$ S3 b' j1 |condo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
  N/ Z# Z7 }1 u4 U5 V# Econstruction mean that record numbers of condos will
# `0 z0 z( q4 |/ ?% F1 Creach completion during 2009. If absorption rates fall, as
" o( J1 |0 y! q/ xcyclical factors would indicate, condo inventories could
! B8 [8 }: _, N! r- yspike severely – particularly in Vancouver. However, while
1 W5 j& ]/ \5 o+ V8 N' _; kresidential construction in B.C. will definitely droop, we
- _) q( v6 G* C0 v+ s" [, h. Ianticipate that the West Coast will continue to benefit from
; U& G  [- [2 W' Q. a9 Minter-provincial and international migration over the coming
6 g+ w8 U+ y6 c6 s, w. i6 _years, which, along with improvements in affordability,
1 x4 E3 W9 U; n, e3 bwill alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
" Y; x( Z9 }4 R, }8 @Grant Bishop, Economist
416-982-8063
& j1 |5 B9 v, D: ^( @! b0 fPascal Gauthier, Economist
416-944-5730

# i$ Y+ V5 U( U5 W, M/ \http://www.td.com/economics/special/gb0409_housing_exec.pdf

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