19 February 2019

Housing will find a floor

Housing construction will slow over the next couple of years but there is unlikely to be a sharp economic downturn as Australia has proved itself flexible enough to undergo transitions without a recession, argues HSBC economist Paul Bloxham.

Housing supply has caught up with demand.

Australia’s apartment building boom is coming to an end, creating considerable angst for many observers.‎ While this will present challenges for some, it is a helpful development from a macroeconomic perspective. After all, if the current rate of building was maintained there would be a risk of too many homes being built.

Some historical context helps. Between 2007 and 2012 not enough housing was constructed to meet the demands of strong population growth. Instead, the nation was busy building lots of mines in response to very high commodity prices. On our estimates, during this period the number of households increased by around 1 million, while the number of dwellings, net of demolitions, rose by only 800,000.

Then came the end of the mining boom, much lower interest rates and the start of the building boom, led by apartments. Since 2012, the number of households has increased by 820,000 and the number of dwellings has risen by around 1 million. In short, supply has caught up with demand. 

Understandably, as the housing boom comes to an end a number of concerns have emerged.

First, housing prices have been falling in the major cities. Aside from more homes being built, increasing supply, demand has also weakened due to other factors such as tighter lending standards and fewer foreign buyers. 

However, despite concerns that this will affect the broader economy, the correction in housing prices has been orderly, with few signs of distressed sales and loan arrears remaining low. The key is that the labour market has remained strong, with the unemployment rate at a seven-year low of 5 per cent. 

Predicting when housing prices will stop falling is a tricky business, particularly as it is unusual for prices to drop when interest rates are low and the jobs market is strong. Our central case is that solid jobs growth and a pick-up in wages should support household incomes, and, in turn, lower property prices should start to attract buyers. We see housing prices stabilising some time in 2019. 

The second concern is that the building boom may have created too many dwellings. At a national level, our estimates suggest that this is unlikely, particularly as housing construction is now nearing its peak. However, there may be an over-supply of apartments in some cities, particularly in Melbourne and Brisbane. These concerns are being partly resolved as strong population growth is absorbing supply in Melbourne and some construction cancellations are helping to clear the Brisbane market. 

More recent concerns have emerged in Sydney, where rental vacancies are rising and rental growth is slowing. Again, the likely solution is continued strong population growth, but there is a risk of a more disorderly adjustment.

The third issue is that tighter financing, particularly for developers, could constrain new construction. This is likely to have contributed to the recent large fall in building approvals for apartments. However, it is also worth keeping in mind that with housing supply and demand now coming into balance, it makes sense that construction slows, whether it is due to developers’ choices or constrained finance.

Finally, as housing construction falls, there is a concern about what is going to fill the ‘growth gap’. A key part of the answer is infrastructure investment. Although Australia is now close to having enough housing to meet the demands of a growing population, there is still a considerable need for more roads, railways, hospitals and schools.

The infrastructure ramp up, which got going in 2016, is set to continue. In just the past year, the pipeline of infrastructure investment, mostly funded by state governments, has expanded by around $10 billion each year for 2019/20 and 2020/21 (or around 0.5 per cent of GDP). This is equivalent to the maximum impact that the housing construction boom had on the economy in 2015 and 2016. In short, the ramp up in additional infrastructure investment that is in the pipeline over the next couple of years should largely offset the fall in housing construction.

As well as infrastructure, solid population growth is supporting demand for services, which is encouraging a lift in business investment. Improved conditions in the mining industry and high rates of capacity utilisation should also see mining investment start to pick up soon, after a long decline.

Although it is likely that overall growth in construction will slow over the next couple of years, we are not expecting a sharp downturn. Of course, pulling off a smooth transition from housing building to infrastructure and business investment will not necessarily be easy. But keep in mind that Australia’s 28-year boom is largely the result of the economy repeatedly proving that it is flexible enough make these sorts of transitions without a recession.

In particular, over the past decade the economy has managed to absorb the largest cycle in investment in mining in the history of our, and that of almost any other country, without a recession. We expect the economy to be able to overcome the current challenges and still maintain solid growth.

This article first ran in The Australian on 18 February 2019