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
3 E" p; k- D0 Q5 X) x4 \, @. }2 aprices exceeded the value of housing that was justified by
# ]; n. s$ t) Tfundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
: d) t0 D2 X3 S0 v" Ythat exceeded its fundamental-justified level by approximately
, S; a9 {) \% n" R7 E  |! t12%, an excess that was exaggerated in the past
; k$ H& j9 W5 Qthree years.
By “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
  K3 S9 U: _5 w' {/ S9 m' jaffordability. The current unwinding of house prices reflects
both a cyclical downturn and a return of house prices
to fundamentally justified levels.
+ Q) N& ]& O* g4 UWe consider “overbuilding” of two forms: “demanddriven”
/ @6 }& M  x" a6 owhere homebuyers buy up too many houses and
1 h4 V* K' h- X8 |that this demand cannot be sustained; and “supply-driven”
where builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
( T: Z# h8 {* b( l“overbuilding” was mainly of the first type, where
homebuyers pushed homebuilding to an unsustainable pitch
9 j7 z; _$ @9 w% y- b, u% g2 U! Y+ \that is now being rapidly reined in.
+ m2 q1 F3 g+ d/ LWhile most markets won’t face U.S.-style overhangs,
the construction of too many new homes over the boom
3 ?2 p  i! y# y$ L- E$ Tmeans 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
remain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
! i; n9 Z; }- O* _is now undershooting fundamentals and we expect this
  s0 `) [3 T0 d+ L7 F& q% ~to persist over 2009 to 2011. We anticipate that nationwide
residential construction will fall further to around
/ h% ?3 ?! I9 W1 t8 i$ U- S125,000 starts over 2009 with a trough around 115,000 units
in the fourth quarter.
To quantify the degree of overpricing and overbuilding,
+ f1 C% k; w: h, g1 L& G; C  _we first develop an empirical model, based on long-run
* h9 a: h# {9 w) v& kfundamentals 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
4 V. D, b- `# \/ h$ H' tlong-run. Since homebuilders build to meet demand, we
regard housing prices and household formation as the drivers
+ H( t* |5 I+ B4 ~# u1 W2 Iof residential construction.
To examine the degree of overbuilding, we employ a
! J1 L% c: M- z" S“counter-factual,” asking what level of residential construction
* d. U  G2 N% Hwould have occurred if housing had been priced
! n# f0 r! n% r6 Y! z, y* Noptimally. We find that actual homebuilding exceeded this
  z  `9 c/ ]! ^1 n( \& O4 Sfundamental-justified level by about 12%. Although new
; w; a' [* p4 r8 V2 s; O( J2 h3 Qunits were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
1 _$ H! x2 l0 k: ^Regionally, we see the greatest strains on the Prairies,
/ |! j; s- K/ w; n4 K# I: Bwhere housing demand will further contract under waning
4 U% K: D  F: {. {3 M. Upopulation inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
& l" g- d3 h' ]/ u' Y* O" A+ avery time that the resale market has swung into strong
3 X+ s- o# K3 gbuyers’ territory. Homebuilding in the Atlantic provinces
  T2 Q) ?/ x. [- @/ ?6 Dhas been relatively balanced but, while not plagued by structural
# a2 b- D9 X1 S' j7 nweakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
strange 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
! p9 k% h1 m6 D2 xcyclical 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
" D' g& u! a' L4 U( ^reach completion during 2009. If absorption rates fall, as
! x6 p7 ]0 k4 u# n# U& b0 \& Icyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
4 H; [2 j4 ~( mresidential construction in B.C. will definitely droop, we
anticipate that the West Coast will continue to benefit from
" _& a& w' o- a  i6 ]3 i7 h0 vinter-provincial and international migration over the coming
5 k8 F9 U' f% r: M7 vyears, which, along with improvements in affordability,
7 Y. f9 k9 @3 `  y" xwill alleviate some of the pressure from overbuilding.
4 u- @5 E$ E4 gOVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
/ I1 `. J/ J( S1 ]( B2 \7 \7 }3 yGrant Bishop, Economist
0 l/ D, {3 V9 j* i& b416-982-8063
1 Q, C* k: \: \% D6 }$ J& gPascal Gauthier, Economist
' G4 \) D: y5 i) X3 a; L416-944-5730

/ ]/ A: W8 X; p7 D4 s8 C6 thttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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