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
& K+ Z' r0 s" @! ~  F$ @' [+ Ounsustainable levels of building. Our view is that house
prices exceeded the value of housing that was justified by
/ m& S8 M0 h- h- s1 L1 d7 F" k+ U5 qfundamentals 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.
By “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
$ M* B- g- b" k# t' ?) M  X3 A& mboth a cyclical downturn and a return of house prices
to fundamentally justified levels.
$ w/ U8 ~* N; g8 K3 R8 H3 i: UWe consider “overbuilding” of two forms: “demanddriven”
+ t0 l6 y! C* |5 W* ~where homebuyers buy up too many houses and
- \1 y6 P7 f, p! k0 x' sthat this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
! o+ h; I2 h% athere is evidence of both types, we contend that Canada’s
! l+ G: f1 n1 x2 l) R2 w. y“overbuilding” was mainly of the first type, where
1 q# w9 j* Z1 vhomebuyers 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
4 i* h9 H3 z: {- S3 eremain choppy and new residential construction will be
$ P+ |: U: h# e5 @dampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
% e  h# N5 n9 I& |0 n- a: `. wresidential 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,
we first develop an empirical model, based on long-run
+ i% f8 H' ]! S6 V1 {) f( V# afundamentals 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
; R4 y" |* b( S0 j3 G: Pof residential construction.
. x- D8 f# Z/ V- {6 X5 |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
" v  k. Q9 O# ?6 |6 e- f2 L' Woptimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
$ _* w! v. K# l1 H" ~. ARegionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
  w  @2 N2 q/ |* Q7 A: ]population inflows. Saskatoon, Calgary and Edmonton are
9 Z3 C) y8 ^  ]% dalready witnessing surges in their unsold new homes at the
very time that the resale market has swung into strong
buyers’ territory. Homebuilding in the Atlantic provinces
  \% P4 H# X% n" phas been relatively balanced but, while not plagued by structural
# Y  b5 B+ _/ g6 Fweakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
7 k3 s) x1 E& F2 i4 c: y5 Sstrange accumulation of unabsorbed multiples on l’Île de
. r( Q7 ^) ^' Y6 h! kMontréal – but recent building has been relatively balanced,
% p5 s4 T1 Y  A, y, C) ^3 T6 n2 ^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
6 N5 l( _1 {4 _, F9 Dlimited – with the important exception of the Toronto
" r! }- Y3 I. L! {. f, |# z5 O& Ncondo market. Both in Toronto and Vancouver, historically
high levels of apartment-style units presently under
construction mean that record numbers of condos will
9 E! ^$ J$ o/ M3 t! p5 C2 v$ lreach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
" k$ j. ?/ y- R4 v$ }" o. |) I' C, rspike 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
6 ^$ C# r, I+ R7 l+ sinter-provincial and international migration over the coming
- y( c$ o! V9 @* }1 J5 F( ?years, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
6 n  i' W) D( p  _" V, j* ROVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
. L) \( Y0 l1 e416-982-8063
Pascal Gauthier, Economist
416-944-5730

http://www.td.com/economics/special/gb0409_housing_exec.pdf

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