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
prices exceeded the value of housing that was justified by
1 `" p. L- y1 V/ \  Qfundamentals by approximately 9% nationwide. This
overpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
' m& P* [  h( j. K12%, an excess that was exaggerated in the past
" R, y- c- B) \" C  \three years.
By “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
! O: a$ X0 [' K9 n* @) i2 n, F+ maffordability. The current unwinding of house prices reflects
both a cyclical downturn and a return of house prices
to fundamentally justified levels.
We consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
; u; J6 i5 t2 w/ T  c" N& q) e. Pthat this demand cannot be sustained; and “supply-driven”
3 j9 ~. f3 D* g1 z, q7 N# bwhere builders accumulate excessive inventories. Although
8 K# X: Q8 q9 b( ?there is evidence of both types, we contend that Canada’s
! H8 t6 j) a- S“overbuilding” was mainly of the first type, where
5 v* x) n% K# Mhomebuyers pushed homebuilding to an unsustainable pitch
* F* b5 w" u( o: ~that is now being rapidly reined in.
$ P# L( b9 M/ XWhile most markets won’t face U.S.-style overhangs,
the construction of too many new homes over the boom
& b$ w# E1 m: g) @: N. s$ Ameans a deepened slump. This overbuilding will likely weigh
on markets over the next few years. Even as Canada recovers
# b0 ?$ N9 m8 E  A8 F2 v2 bfrom the cyclical downturn, house price growth will
% m# |7 r+ D! V0 T- hremain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
4 y1 d, P- x9 j. d+ z1 O, Bis now undershooting fundamentals and we expect this
) n+ _( P& A% B+ Uto persist over 2009 to 2011. We anticipate that nationwide
4 I9 E* p6 s. C" D. z- Iresidential construction will fall further to around
% J& t) E- ]7 ?. v# M& a, }125,000 starts over 2009 with a trough around 115,000 units
. I& _3 X! |# u; {2 _$ Cin the fourth quarter.
To quantify the degree of overpricing and overbuilding,
% @, z4 ?5 R* _6 H  uwe first develop an empirical model, based on long-run
fundamentals of house prices and housing starts in each
province. Affordability is the key concept behind home
* s: Q3 \$ A$ ?  qvalues 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
of residential construction.
. G8 [! z8 y; V, @' x8 KTo examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
1 j8 a9 N) H& _; G8 S% dunits were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
: l; E% ]1 ^! K, _Regionally, we see the greatest strains on the Prairies,
+ g' @& e' b  _# e! [0 b$ W. Uwhere housing demand will further contract under waning
; e$ t! \/ O3 D$ Npopulation inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
very time that the resale market has swung into strong
- w! v7 S0 T% F) \8 L# [buyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
weakness, will be singed by the downturn nonetheless.
8 ]' b) t, E0 Q* V* m' VQuébec shows signs of strain – especially given the
! a! v; F- R+ q# C8 K* Astrange accumulation of unabsorbed multiples on l’Île de
' j7 f- N  Q5 ~3 r/ WMontréal – but recent building has been relatively balanced,
+ `. n* h) {$ {" u" pgiven the province’s history of under-building and low ownership
7 }) d! J0 l; \rates. While Ontario homebuilding will reel from a
8 v7 _$ w( ^( q$ H/ e; O6 r7 g2 zcyclical downturn, the degree of structural weakness appears
, t; k9 ]' z& {' b. H6 `, Hlimited – with the important exception of the Toronto
* i" l2 y* X. k7 J( _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
spike severely – particularly in Vancouver. However, while
- c6 ?. ?. U- J4 sresidential construction in B.C. will definitely droop, we
& y: _5 n7 K; @4 @- G7 G# Santicipate that the West Coast will continue to benefit from
- Z$ u# ?* `  R" Q, z, M! Q. Xinter-provincial and international migration over the coming
. a) F9 U+ N, `3 L" qyears, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
& g8 R5 r8 o! j* X) Z3 YOVERPRICED AND OVERBUILT: CANADIAN HOUSING
8 S4 @& {+ A* |) xMARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
/ R6 h! e! I0 @" a' pPascal Gauthier, Economist
416-944-5730

8 ~7 ~# L- I6 C4 F& y2 uhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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