TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
0 D- @. e3 y' P$ z* D0 ?from 2002 to 2008, unsustainable price increases drove
$ d/ J0 i5 h- B/ l: sunsustainable levels of building. Our view is that house
# W+ n1 g" D8 d/ @8 @# Wprices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
) Y$ m( q2 N7 j7 hoverpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
! H; g$ j- U- T/ ythree years.
By “overpricing” we mean that prices detached from
# X; {7 u4 G3 X0 @0 Itheir fundamentals, as witnessed by a steep erosion of
8 O4 t' h. a. |) B) }affordability. The current unwinding of house prices reflects
" o/ p8 O/ U1 w% d* }+ Oboth a cyclical downturn and a return of house prices
to fundamentally justified levels.
% X6 l) L& K+ D( a% E" X6 XWe 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
there is evidence of both types, we contend that Canada’s
# V  [5 _5 x' ~! l: i“overbuilding” was mainly of the first type, where
0 Q" q: V" o, l3 n  J2 Ghomebuyers pushed homebuilding to an unsustainable pitch
that is now being rapidly reined in.
  t$ a% J$ {* O) Y( R2 F7 {While most markets won’t face U.S.-style overhangs,
  V, U8 a  g/ ^# Hthe construction of too many new homes over the boom
means a deepened slump. This overbuilding will likely weigh
; {0 b" F* z/ Gon markets over the next few years. Even as Canada recovers
% v# N" e/ U7 M& U2 Nfrom the cyclical downturn, house price growth will
1 V" q5 X# C( {* ?: Nremain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
' o$ B  ]3 ]8 w" B/ m# r0 E" g' F6 J1 Cis now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
( @% Q( B/ F4 o! C/ f: Dresidential construction will fall further to around
125,000 starts over 2009 with a trough around 115,000 units
* q+ ^6 ^. l: Y2 o. }1 Y- E( Vin the fourth quarter.
8 k" E1 F5 |% S0 |: aTo 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
8 K9 b/ S% K0 b. qprovince. Affordability is the key concept behind home
/ y1 T3 b; W; q4 q; c9 mvalues since house prices should track incomes over the
& Y' l' J+ W1 i2 v4 u- G7 h( B! Flong-run. Since homebuilders build to meet demand, we
regard housing prices and household formation as the drivers
$ J. k7 s- {0 Y' ~of residential construction.
To examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
" J! R- @4 e' {- r. z  r0 A) Ewould have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
3 k1 D" P5 K8 H* Y7 G  Fmany houses at prices that exceeded fundamentals.
0 v' W3 a' x2 s8 k/ t7 [Regionally, we see the greatest strains on the Prairies,
+ p& Q; `' G: A! M* T* w8 d1 Y2 ]where housing demand will further contract under waning
* ]! i7 `+ z& G  `% z- ]+ `population 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
( [4 T) q9 b7 y2 P5 ?( z6 ~; @buyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
6 Q; j- N& Z! ^" x2 nweakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
3 w1 x( A0 ?: c; Dstrange accumulation of unabsorbed multiples on l’Île de
Montréal – but recent building has been relatively balanced,
/ p9 b/ u" P) r3 O6 j* S& i+ }given the province’s history of under-building and low ownership
( k4 O% j( c8 v. Prates. While Ontario homebuilding will reel from a
" ^4 d- _, A( q: ccyclical downturn, the degree of structural weakness appears
1 Z8 A* }- F% |limited – with the important exception of the Toronto
( p1 W* B/ a+ U+ g5 qcondo market. Both in Toronto and Vancouver, historically
& q5 K6 f4 D* Y& ohigh 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
! }# j+ x0 ]/ n+ D( p+ s( Ispike severely – particularly in Vancouver. However, while
residential construction in B.C. will definitely droop, we
* q' [3 m, G4 R7 w2 Z# B& u6 Fanticipate that the West Coast will continue to benefit from
/ k2 c$ u0 @$ J, \inter-provincial and international migration over the coming
1 U6 L6 _- V& K2 l0 w* {# Ayears, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
6 M& s# m; w4 B% T+ `2 jGrant Bishop, Economist
416-982-8063
( \+ c. x4 E9 I0 q' D; pPascal Gauthier, Economist
416-944-5730

: Z6 c- g- w( E  S* \http://www.td.com/economics/special/gb0409_housing_exec.pdf

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