TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
) t6 ~/ ?9 x" T4 z) Tfrom 2002 to 2008, unsustainable price increases drove
unsustainable levels of building. Our view is that house
) u* H. W, M. z; ~prices exceeded the value of housing that was justified by
fundamentals by approximately 9% nationwide. This
+ P$ S; l, n4 d" o; ^overpricing compelled a level of residential construction
that exceeded its fundamental-justified level by approximately
) H1 {; P2 ?" \3 ?: @4 p! y12%, an excess that was exaggerated in the past
three years.
By “overpricing” we mean that prices detached from
, F( B9 K% \5 U% p2 A* \" ~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.
We consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
9 u) O" z3 Y4 Q/ Z$ cwhere builders accumulate excessive inventories. Although
( t  l6 u- @1 |: e2 J7 c, f( j4 ~there is evidence of both types, we contend that Canada’s
+ p1 v8 _+ x3 \5 i3 N$ Z“overbuilding” was mainly of the first type, where
4 I8 E7 i% v! _+ f# l& q1 H/ lhomebuyers pushed homebuilding to an unsustainable pitch
$ I6 B! x/ t) P8 h$ H7 n% Jthat is now being rapidly reined in.
  c( s8 {& E( O  p/ b1 h+ C/ LWhile most markets won’t face U.S.-style overhangs,
' x, O3 d: f& W* Q/ othe construction of too many new homes over the boom
means a deepened slump. This overbuilding will likely weigh
! `- l9 m1 I" \  h- won markets over the next few years. Even as Canada recovers
/ x. d9 {7 X; |. `: i; Kfrom the cyclical downturn, house price growth will
remain choppy and new residential construction will be
4 U% c# F$ p- U& idampened, owing to this structural weakness. Construction
8 S( A! B7 p" p* A: Xis now undershooting fundamentals and we expect this
4 W( i1 J! J9 J$ o0 E1 Hto persist over 2009 to 2011. We anticipate that nationwide
residential construction will fall further to around
0 m2 G0 c/ j# d125,000 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
7 }( C3 ^* {/ b! q' i5 T' s) e9 v% qfundamentals of house prices and housing starts in each
* U* c6 p+ F8 J3 ^; a2 k6 O, a" r# m! [province. Affordability is the key concept behind home
% u% s" b3 B* ~, v- `! N% dvalues since house prices should track incomes over the
$ @& k# Y* d' l) Nlong-run. Since homebuilders build to meet demand, we
, \+ H4 [2 m. V3 N: Q/ lregard housing prices and household formation as the drivers
0 I; U& E/ E! L% E6 u3 r' t( Vof residential construction.
0 q  B) Q: Y4 L: q1 J; n8 lTo examine the degree of overbuilding, we employ a
$ m7 [$ D& Z2 z“counter-factual,” asking what level of residential construction
2 M/ k' v! `" S$ |- R& |would have occurred if housing had been priced
& |% M: d& I- k" {- ?+ zoptimally. We find that actual homebuilding exceeded this
2 x! z* C/ W$ U3 w0 Q2 K) Pfundamental-justified level by about 12%. Although new
" f3 a: L6 [+ E; c0 Aunits 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
2 N' ~7 s9 [% K. Jpopulation inflows. Saskatoon, Calgary and Edmonton are
7 m' Z' \6 B1 J& H, aalready witnessing surges in their unsold new homes at the
+ }* e7 l! P$ \, M) F) ?very time that the resale market has swung into strong
. Z1 r! n: Z9 ], Zbuyers’ territory. Homebuilding in the Atlantic provinces
has been relatively balanced but, while not plagued by structural
6 Z0 I1 G3 C2 `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
- b9 @( ]# R" E2 w- s! wMontréal – but recent building has been relatively balanced,
, t2 U* w+ `3 @) M# L2 Z3 A' y' M: y9 cgiven the province’s history of under-building and low ownership
; z) H" h' D/ Y$ Yrates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
  l- Z8 l+ y/ L9 G( ilimited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
% `  J) Z8 G. V4 D! b, L( n* khigh 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
4 Q% h$ D* R* y# Z5 wresidential construction in B.C. will definitely droop, we
+ {: L0 J: h/ G- F) W, e; ~anticipate that the West Coast will continue to benefit from
' s7 T* \- L$ W4 t2 Y/ Yinter-provincial and international migration over the coming
4 j& I' R; b/ C) E9 Myears, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
4 s4 ?- l; s" Q' G' ~; L+ {Grant Bishop, Economist
7 X, c: Z% f" E% Y7 [; M416-982-8063
Pascal Gauthier, Economist
7 `1 |/ q( T7 m% w% _' F3 C416-944-5730
6 l" ~: ^" |, l# ]4 p
2 @2 Q3 [' L7 q5 Q* t3 l* ^http://www.td.com/economics/special/gb0409_housing_exec.pdf

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