TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
/ R, }% r* L2 m" @1 [1 Ofrom 2002 to 2008, unsustainable price increases drove
unsustainable levels of building. Our view is that house
9 E% ]- i, m7 y& Q3 Cprices exceeded the value of housing that was justified by
# t' r- q3 |$ ~$ Y5 |8 q; c! y0 Lfundamentals by approximately 9% nationwide. This
  u) ^' c' c8 toverpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
. U3 t+ r' W2 M) Q12%, an excess that was exaggerated in the past
8 _. B+ p7 d) Bthree years.
  ?: ?- m9 y5 o! A( iBy “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
( ]2 {7 |. p7 gaffordability. The current unwinding of house prices reflects
both a cyclical downturn and a return of house prices
to fundamentally justified levels.
# L, o& v- Y8 x+ X5 sWe consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
* J: m" d( e% C! I' J4 ]) Z  Vwhere builders accumulate excessive inventories. Although
) l; E+ \8 O: k& w7 T0 Hthere is evidence of both types, we contend that Canada’s
, V% w5 w2 r4 Z2 K- N. O“overbuilding” was mainly of the first type, where
) G( n+ ~. N2 I% ^; r( n+ ~homebuyers pushed homebuilding to an unsustainable pitch
/ `4 W+ H' [/ J4 T3 c3 M9 h( {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
+ K9 I  S- V" i2 \" Lfrom the cyclical downturn, house price growth will
* X: ^' Y6 d* p, Vremain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
7 z/ q7 F; g  U9 N$ lis 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.
& M8 }) e! p! r4 K3 h* qTo quantify the degree of overpricing and overbuilding,
we first develop an empirical model, based on long-run
fundamentals of house prices and housing starts in each
  Q7 Z. X/ v& ]5 [* Cprovince. 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
# Y' Q6 m7 E* Y# zof residential construction.
To examine the degree of overbuilding, we employ a
( {8 P0 |( s' d“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
, o* k! X* w6 D+ h5 I6 Doptimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
/ B9 [7 X+ X; \( m9 eunits were being absorbed, homebuyers simply bought too
% H0 B  @9 m) a, u/ ymany houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
2 e# c0 q8 j8 \: k/ ], A( Xwhere housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
$ S; ]1 W; J9 \* _$ calready witnessing surges in their unsold new homes at the
. v; E: |' }' j. w# Overy time that the resale market has swung into strong
buyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
9 N& E9 e4 M: |/ @weakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
/ s5 W9 @* L! H( Estrange 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
: P% E# A# B) crates. While Ontario homebuilding will reel from a
+ X& M" ]. j7 j2 b* }) Y# Ocyclical 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
) U, |) Y* ^! g7 S. a; w5 yconstruction mean that record numbers of condos will
0 V4 ~1 K5 ^1 }$ y: ^8 Wreach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
" i$ u4 P/ z0 g0 ~! Ispike severely – particularly in Vancouver. However, while
residential construction in B.C. will definitely droop, we
+ t: g. g) _) c6 d( Z+ Nanticipate that the West Coast will continue to benefit from
$ g5 ~3 k! `5 Sinter-provincial and international migration over the coming
years, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
" C2 ?% q' J( ^3 j; ?OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
& o: ]+ L$ s: ?+ ~# T6 CGrant Bishop, Economist
416-982-8063
Pascal Gauthier, Economist
416-944-5730

( f' Z, H+ N  l! k! c! whttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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