TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
( K# m/ f; L- V6 Z. Mfrom 2002 to 2008, unsustainable price increases drove
unsustainable levels of building. Our view is that house
* O3 h5 a' ]% S, ?prices exceeded the value of housing that was justified by
7 i+ {, `% J0 y" ~" o) Y8 y. k1 G8 X; Tfundamentals by approximately 9% nationwide. This
  L9 z- t: d, z9 `: @3 A  U" Zoverpricing compelled a level of residential construction
; D* T4 `8 X5 `that exceeded its fundamental-justified level by approximately
12%, an excess that was exaggerated in the past
three years.
4 c' Q, |3 y. m3 i  n4 Q  a% zBy “overpricing” we mean that prices detached from
6 v. L1 P% w# ftheir fundamentals, as witnessed by a steep erosion of
3 ~/ u1 h/ F; `, p! Q; uaffordability. 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”
# z8 B+ Z" {  \" Ywhere homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
. |8 G3 N. U; k9 Zwhere builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
5 A% J# c1 ^. c$ k+ mhomebuyers pushed homebuilding to an unsustainable pitch
, W5 j* N7 P4 t  @that is now being rapidly reined in.
4 s* K2 Y0 o, W. g, S# s. g8 m# }While most markets won’t face U.S.-style overhangs,
8 u6 b9 v, x: pthe construction of too many new homes over the boom
" s$ l( k; W! f# z9 i" xmeans a deepened slump. This overbuilding will likely weigh
' l; b5 d4 j2 E1 Aon markets over the next few years. Even as Canada recovers
from the cyclical downturn, house price growth will
" T# x7 Q9 e1 m/ b2 z2 nremain choppy and new residential construction will be
  v; z0 E- s: J4 X- sdampened, owing to this structural weakness. Construction
& l  I4 S% @# l" K+ L3 ^is now undershooting fundamentals and we expect this
to persist over 2009 to 2011. We anticipate that nationwide
2 I; `) j! [# W, a2 vresidential construction will fall further to around
3 S9 ^. l; Z, f) y7 @! C$ ~) `125,000 starts over 2009 with a trough around 115,000 units
4 {: o: p, n9 D. ?3 }3 S2 B* G$ nin the fourth quarter.
5 _% M* h+ p+ C2 S! t) `3 o7 FTo quantify the degree of overpricing and overbuilding,
we first develop an empirical model, based on long-run
# m& v6 _, [  N* Ffundamentals 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
& J% o0 o4 k  z8 Olong-run. Since homebuilders build to meet demand, we
regard housing prices and household formation as the drivers
of residential construction.
# |: {. p9 [1 e! Q! qTo examine the degree of overbuilding, we employ a
+ A) ~* {9 z5 D1 v) Q“counter-factual,” asking what level of residential construction
; e- U( T7 G$ H8 f2 Pwould have occurred if housing had been priced
optimally. We find that actual homebuilding exceeded this
; O  f: y1 e8 B* Wfundamental-justified level by about 12%. Although new
* ?8 R4 Q3 I, {& E' S( Q) ]units were being absorbed, homebuyers simply bought too
6 e8 T) r6 d+ nmany houses at prices that exceeded fundamentals.
" G' a! H1 a% J* a5 n" nRegionally, 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
; x1 O  }5 J& u  G2 h" _4 hvery time that the resale market has swung into strong
buyers’ territory. Homebuilding in the Atlantic provinces
! G" x! M; u/ G  w9 l% o% qhas been relatively balanced but, while not plagued by structural
' I7 A' Q# t3 }' |1 qweakness, will be singed by the downturn nonetheless.
' A. Y, z' N8 K1 O9 \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
4 A# U& v6 G6 B& K% X1 grates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
* a  y9 ?, u& s4 G; f& Xlimited – with the important exception of the Toronto
condo market. Both in Toronto and Vancouver, historically
( _. O; R. p0 Q( K2 vhigh levels of apartment-style units presently under
0 b( }4 C1 b: Rconstruction mean that record numbers of condos will
reach completion during 2009. If absorption rates fall, as
cyclical factors would indicate, condo inventories could
' U/ A1 v5 w$ e: C) K" ], O# x# vspike severely – particularly in Vancouver. However, while
residential construction in B.C. will definitely droop, we
/ t5 S, `% L; panticipate that the West Coast will continue to benefit from
inter-provincial and international migration over the coming
2 z% O, Q! ?6 s2 ^years, which, along with improvements in affordability,
will alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
9 F. C6 \+ Q! K/ @* oGrant Bishop, Economist
416-982-8063
5 `: S7 k  M: o8 T! l- d" h$ ZPascal Gauthier, Economist
% m, T; U, h  K1 m* ?! U( R* o416-944-5730
( T0 g4 W6 ~. r- t6 a- b6 G6 A" n
. ~1 P0 m9 Q) o3 x7 hhttp://www.td.com/economics/special/gb0409_housing_exec.pdf

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