TD Bank:OVERPRICED AND OVERBUILT: CANADIAN HOUSING

依勒特

During Canada’s “Housing Boom”, which ran roughly
- Q* B* ~( W3 e) ?from 2002 to 2008, unsustainable price increases drove
1 |1 R! z: X) }. K( h) Aunsustainable levels of building. Our view is that house
8 H8 t7 X2 D2 n- x! v/ z$ W% F; mprices exceeded the value of housing that was justified by
* z! z) m6 K/ @& pfundamentals by approximately 9% nationwide. This
6 x# i5 i/ s  w6 e7 d' m, `overpricing compelled a level of residential construction
) X3 ~3 n% }8 S* y# R2 m5 ^that exceeded its fundamental-justified level by approximately
- N2 Z; g& l! D; L& h2 f2 u12%, an excess that was exaggerated in the past
& f3 U9 K( [- c# n' Lthree years.
5 U. [5 C; I, X. ]! O4 `. ]) rBy “overpricing” we mean that prices detached from
their fundamentals, as witnessed by a steep erosion of
- C. m, @) b" ^0 Daffordability. The current unwinding of house prices reflects
* R6 k2 _  ]5 r, eboth a cyclical downturn and a return of house prices
" v- {! X+ u3 b% _to fundamentally justified levels.
3 ]6 L  \6 k' {0 FWe consider “overbuilding” of two forms: “demanddriven”
where homebuyers buy up too many houses and
that this demand cannot be sustained; and “supply-driven”
- }, x" {# U/ h2 i  S2 ywhere builders accumulate excessive inventories. Although
there is evidence of both types, we contend that Canada’s
“overbuilding” was mainly of the first type, where
' D" X) e7 `) {homebuyers pushed homebuilding to an unsustainable pitch
+ o- N* S) f6 U. f, |1 H. \8 fthat is now being rapidly reined in.
1 u0 q% B5 I( X* r$ `2 W9 JWhile most markets won’t face U.S.-style overhangs,
the construction of too many new homes over the boom
means a deepened slump. This overbuilding will likely weigh
on markets over the next few years. Even as Canada recovers
/ l  `" B! f3 e2 b; F3 Hfrom the cyclical downturn, house price growth will
: k7 \1 o, w5 f$ Yremain choppy and new residential construction will be
dampened, owing to this structural weakness. Construction
1 h) I9 R8 M" b2 [% h+ ris now undershooting fundamentals and we expect this
- k, q$ w5 g2 a+ ?to persist over 2009 to 2011. We anticipate that nationwide
5 [, E, O% k- b. c" a4 z" H7 B" Jresidential construction will fall further to around
# T* Y! m" O7 b$ \4 V7 R125,000 starts over 2009 with a trough around 115,000 units
. s1 g5 `. C3 p9 bin the fourth quarter.
7 n" Z  M2 o3 e; y9 DTo quantify the degree of overpricing and overbuilding,
we first develop an empirical model, based on long-run
' Z, r! J0 O2 r+ ~5 B9 N4 O& [fundamentals of house prices and housing starts in each
  f2 h8 l0 V8 o, ]- t! V1 U" T7 i: Uprovince. Affordability is the key concept behind home
values since house prices should track incomes over the
& b  r& T% }: k& B' ~( ylong-run. Since homebuilders build to meet demand, we
regard housing prices and household formation as the drivers
$ G6 y& Q, d# G! K: @of residential construction.
To 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
& E, x& B: a4 w2 ~4 z$ M& _units were being absorbed, homebuyers simply bought too
many houses at prices that exceeded fundamentals.
( a  j; b2 e9 T3 i. P/ N/ wRegionally, we see the greatest strains on the Prairies,
5 q7 h% @; Y* j$ q" d! pwhere housing demand will further contract under waning
population inflows. Saskatoon, Calgary and Edmonton are
9 \: R' n7 L7 g/ }$ s5 ]; @' Qalready witnessing surges in their unsold new homes at the
very time that the resale market has swung into strong
buyers’ territory. Homebuilding in the Atlantic provinces
1 u7 u; j3 k( M) a9 e" V  ]& g/ Khas 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
Montréal – but recent building has been relatively balanced,
) k4 v8 ^. S& L/ d* r7 Tgiven the province’s history of under-building and low ownership
rates. While Ontario homebuilding will reel from a
cyclical downturn, the degree of structural weakness appears
4 U. J- j+ T( Q: Climited – with the important exception of the Toronto
7 H$ P0 K) R: x) D& Hcondo 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
; w* j" ?2 _% F: \6 L; y. Z* Xcyclical factors would indicate, condo inventories could
spike severely – particularly in Vancouver. However, while
( c2 G+ B$ g, R- m& [5 o& P% Presidential construction in B.C. will definitely droop, we
anticipate that the West Coast will continue to benefit from
3 ?/ R8 M0 y3 ^9 @, Z. G7 Qinter-provincial and international migration over the coming
! i4 A  E1 K9 K! l% ?years, which, along with improvements in affordability,
6 ^% v8 p' s. s* h: j2 K$ T/ Dwill alleviate some of the pressure from overbuilding.
OVERPRICED AND OVERBUILT: CANADIAN HOUSING
MARKET RETURNS TO FUNDAMENTALS
Grant Bishop, Economist
416-982-8063
Pascal Gauthier, Economist
416-944-5730

http://www.td.com/economics/special/gb0409_housing_exec.pdf

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