TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
& q1 Q( m  ~# U# f; C/ ?from 2002 to 2008, unsustainable price increases drove
unsustainable levels of building. Our view is that house
3 @# M- b8 N  N* c8 _; E5 C) Cprices exceeded the value of housing that was justified by
6 A4 J) L+ }* f. J8 T2 Jfundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
) r& j2 ]; ]  f# ^# z& i5 y7 ~  B! fthat exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
; P$ i$ n3 M/ ithree years.
/ [9 C$ p& s9 `By “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
+ t5 R7 S: g) Y& A* b" kaffordability. The current unwinding of house prices reflects
, h, |9 T/ o- S2 H( t* ^+ vboth a cyclical downturn and a return of house prices
# j$ k: M1 j% p% J+ s0 s& Zto fundamentally justified levels.
2 L2 M+ x) |& K" M8 I- A% GWe consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
% ^$ V# `: P- I! u+ M& Gthere is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
While most markets won’t face U.S.-style overhangs,
8 P. ~+ K+ C; v0 othe construction of too many new homes over the boom
0 B0 P: \% J" B$ P( j# g. y. tmeans a deepened slump. This overbuilding will likely weigh
on markets over the next few years. Even as Canada recovers
* H8 ^2 k5 e6 {0 g0 o) c/ Qfrom 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
# M. B( v3 t% a+ `1 ~, s( Rto 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,
we first develop an empirical model, based on long-run
* E4 J8 g0 E0 o+ z6 Pfundamentals of house prices and housing starts in each
province. Affordability is the key concept behind home
( K9 k* ]1 ?" L; p) J9 H6 d$ yvalues since house prices should track incomes over the
long-run. Since homebuilders build to meet demand, we
) z1 U6 j& B8 g& D1 l4 Mregard housing prices and household formation as the drivers
of residential construction.
% S) b1 _8 R* N% H3 G5 rTo examine the degree of overbuilding, we employ a
& ^) Q6 U  r1 N- \7 T+ k“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
, z/ m$ [" o% m/ S$ B+ I8 Joptimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
+ h( p0 f; N- F# C1 U& [+ J7 imany houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
6 {7 z) H+ s% a+ Z3 |& i. ?. hwhere housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
: P8 C, A6 k# T; [. Kvery time that the resale market has swung into strong
buyers’ territory. Homebuilding in the Atlantic provinces
6 e$ V# h. Y3 h6 }2 f" i, Khas been relatively balanced but, while not plagued by structural
weakness, will be singed by the downturn nonetheless.
6 w9 n" u3 X2 u$ A% O) RQuébec shows signs of strain – especially given the
7 f) j5 |1 S: {8 astrange 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
condo 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
2 P0 D# z. h! c. b3 jspike severely – particularly in Vancouver. However, while
6 z$ f* E& v  v- O! O& g8 Qresidential 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
+ X1 `; c$ r! pyears, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
& E" L3 G/ n. f. v- V) @OVERPRICED AND OVERBUILT: CANADIAN HOUSING
1 p' g3 r8 Z) A  }  fMARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
Pascal Gauthier, Economist
416-944-5730
; A; ^) \) R8 O) Q, t
# V0 v2 H/ U( o4 Z7 \http://www.td.com/economics/special/gb0409_housing_exec.pdf

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