TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
; O- p7 B) ^6 o/ g; H, |/ bfrom 2002 to 2008, unsustainable price increases drove
* D1 o  ]/ C0 z9 j2 eunsustainable levels of building. Our view is that house
prices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
7 K& p4 B% D, a( v! K" Y" R/ Koverpricing compelled a level of residential construction
9 E2 O$ [0 H8 q5 d  L- A6 nthat exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
5 l2 ]5 t. c& {. X/ y7 D! Ythree years.
' i% W  x9 ]& p3 U" N1 hBy “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
affordability. The current unwinding of house prices reflects
both a cyclical downturn and a return of house prices
to fundamentally justified levels.
4 s0 W8 ?; ^" J: UWe 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
+ n* V, h* h, ?( h9 w, a1 x! Othere is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
: k+ R3 K  U, p: _0 n$ k  mhomebuyers pushed homebuilding to an unsustainable pitch
- y% J" o- o( w; I9 Ithat is now being rapidly reined in.
3 g$ u& q% h" d( m- L' Y9 wWhile most markets won’t face U.S.-style overhangs,
the construction of too many new homes over the boom
% C+ d" T' X  ]' a, S. Emeans 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
$ w9 o- N8 K8 M  u$ b  Odampened, owing to this structural weakness. Construction
is now undershooting fundamentals and we expect this
9 v* I0 n: ]! u# Q; e4 S4 uto persist over 2009 to 2011. We anticipate that nationwide
residential construction will fall further to around
+ F" {( e- @  D/ M+ v: }4 L8 S' h125,000 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
fundamentals of house prices and housing starts in each
* g, b% m' }! R3 Z0 \9 Q3 t  r! xprovince. Affordability is the key concept behind home
* f1 z7 U) Z2 @. m! O; Nvalues since house prices should track incomes over the
( T7 Y. N: b: a; |9 D: x( D' V; olong-run. Since homebuilders build to meet demand, we
% s) D* H3 @2 S6 lregard housing prices and household formation as the drivers
of residential construction.
4 O7 x8 h& }( Y* v& UTo examine the degree of overbuilding, we employ a
“counter-factual,” asking what level of residential construction
would have occurred if housing had been priced
- ?& R+ \( h; J/ s+ eoptimally. We find that actual homebuilding exceeded this
fundamental-justified level by about 12%. Although new
units were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
Regionally, we see the greatest strains on the Prairies,
where housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
already witnessing surges in their unsold new homes at the
6 H3 O. e/ j; R7 every time that the resale market has swung into strong
5 y9 U: m% B+ O  \6 l, ]/ Vbuyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
weakness, will be singed by the downturn nonetheless.
Québec shows signs of strain – especially given the
strange accumulation of unabsorbed multiples on l’Île de
3 Z7 Y* g1 c. }; x4 f' W+ ~0 a: |* DMontréal – but recent building has been relatively balanced,
given the province’s history of under-building and low ownership
9 l3 I. ?) G6 f* ?) W$ grates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
) u& I3 W+ s. d5 D. N: v: ]7 ^limited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
8 J$ G& ~  E. p; shigh levels of apartment-style units presently under
construction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
6 Z7 ~. g9 t" A6 Z5 Xcyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
0 h& @/ z# n6 f) S. G+ T! nresidential construction in B.C. will definitely droop, we
! C" _7 b4 A1 T! Manticipate that the West Coast will continue to benefit from
inter-provincial and international migration over the coming
years, which, along with improvements in affordability,
3 p4 B/ B6 s6 d+ i4 ^& Lwill alleviate some of the pressure from overbuilding.
: z. V6 \5 F  C) d& jOVERPRICED AND OVERBUILT: CANADIAN HOUSING
$ M+ N0 N5 D1 M# i" l" I& ^MARKET RETURNS TO FUNDAMENTALS
! J/ v. `# s: G+ MGrant Bishop, Economist
5 H% a+ {8 ^, d  O& C416-982-8063
8 U  u; Q) S2 W4 k( L2 BPascal Gauthier, Economist
416-944-5730
5 Y7 |  ~) F  D+ P: {$ n5 H
http://www.td.com/economics/special/gb0409_housing_exec.pdf

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