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Australian apartment construction is about to tank -- but it looks like the cavalry is coming

David Scutt

After an unprecedented building boom over the past few years, there's no shortage of bearish of forecasts on the outlook for Australian residential construction.

To many, the boom will turn to a bust, weighing not only on the sector and its employees, but the broader Australian economy.

BIS Economics is the latest to warn about what lies ahead, releasing a report this week suggesting that residential construction will slump 31% over the next few years, lead by a collapse in apartment building which is expected to halve from the record levels seen in the 2015/16 financial year.

“Overall the slump will be similar in percentage terms to the residential downturns in the mid-1990s and the introduction of the GST in 2000-01,” says Adrian Hart, Associate Director of Construction, Maintenance and Mining at BIS Oxford Economics.

“Over the next two years, the fall in residential building starts will accelerate sharply, particularly in the investor-driven apartments segment, as supply catches up to underlying demand.”

It sounds dramatic, but BIS economics is not alone in delivering a glum assessment.

Earlier this year, Australia's Housing Industry Association (HIA) said that new dwellings commencements would fall to 177,000 in the 2018/19 financial year, well below the record peak of 231,000 that began construction in the 2015/16 financial year.

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And, like BIS Economics, it too forecasts that the slide will be driven by the apartment sector.

“The multi-unit side of the market is expected to drive the downturn in residential building, with commencements on this side of the market projected to fall by 41% from peak to trough,” the group said.

The HIA cited a “hit” to investor demand from recent regulatory changes, along with “obstacles to foreign investor participation”, as two factors that would contribute to the sharp decline.

A slump of such magnitude, understandably, has created some anxiety about what it may do to the residential construction sector, the third-largest employer in the country behind healthcare and retail, and a crucial cog in the broader Australian economy.

However, while few dispute that apartment construction will fall in the years ahead, mirroring a substantial decline in apartment approvals in official data released by the Australian Bureau of Statistics (ABS), there are more than a few reasons to remain optimistic that the construction industry won't fall in a heap, dragging the economy along with it.

The construction cavalry is coming, both from non-residential construction and the home building sectors.

Take the recent Performance of Construction Index (PCI) report from the Australian Industry Group (Ai Group) as a prime example as to why all is not lost for the sector.

In July, the PCI -- a measure of changes in activity levels from one month to the next -- rose to 60.5 points, the highest level in the 12-year history of the survey, led by strong performances by engineering, commercial and detached housing construction.

The fastest improvement in activity levels since at least 2005.

Let that sink in.

For all the pessimism over the slowdown in apartment construction, it seems the industry is taking it in its stride, and then some.

Individual readings on activity levels for commercial, housing and engineering construction stood at 64.3, 62.4 and 57.5 respectively, indicating a rapid improvement not only from a month earlier, but also the course of this year.

Any reading above 50 signals that activity levels are improving, with the distance away from 50 indicating how quickly it occurred.

“The rate of expansion in commercial construction lifted to its highest level in 12 years amid an increase in the number of projects entering the work pipeline. House building recorded its fastest pace of growth in 3.5 years on the back of a solid backlog of work and ongoing strength in demand," the Ai Group said.

“More robust conditions were also evident in engineering construction activity in July, with the sector’s sub-index rising solidly in line with reports of increased levels of non-mining infrastructure work,” it added.

While the PCI measures sentiment, not actually what's happened on the ground, there's little doubt that the sector is booming in mid-2017.

However, while things are looking good right now, the concern still lies around what will happen in the future.

Well, the survey had good news on that front too.

The new orders subindex -- a led indicator on futures levels of activity -- jumped to 64.6 in July.

Like the headline PCI, a reading above 50 indicates that orders grew. So at 64.6, that suggests new order volumes were rolling in rapidly during the month.

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By individual sector, the Ai Group said that the new order subindices for housing, commercial and engineering came in at 63.1, 74.2 and 56.5 respectively, pointing to surge of new work across the broader construction sector.

At 66.7, the apartment new order subindex was also strong, fitting with a surge in apartment approvals in the official statistics from the ABS for June.

The chart below shows the rapid improvement in new orders across the various construction subsectors, underlining that new orders are now growing faster than at any point in recent years -- and that was during the peak of Australia's residential construction boom.

“Across the construction industry growth in new orders and activity accelerated in July to rates that were among the strongest in the survey’s 12-year history,” the Ai Group said.

Fitting with that surge in new order volumes, the survey also found that employment across the sector grew at the fastest pace in almost three years as firms positioned for an influx of new work in the period ahead.

That's hardly a scenario that points to a bleak outlook for the sector.

If anything, it merely suggests that the growth baton in the sector is being slowly passed from apartment construction to non-residential and unattached housing work.

Adding to the upbeat outlook for the broader construction sector, and helping to explain the strength in the July PCI report, separate data released by CoreLogic earlier this week revealed that the pipeline of new construction work currently sits at elevated levels, led by civil engineering works.

According to the group's latest Construction Monthly report, the pipeline of new work across Australia stood at $21.7 billion in July, leaving it well above the 12-month average of $14.6 billion per month.

CoreLogic said that civil engineering made up the largest contribution to new projects, accounting for 45% of the 2,087 projects captured in the July report.

And, as seen in the chart below, civil engineering accounted for over half of the total value of new works, more than doubling the 25% contribution made by apartments.

Combined, all the recent data points to the likelihood that activity levels across the construction sector will remain firm over the coming years, with non-residential work and an expected modest downturn in unattached housing construction set to offset much of the effects of the decline in apartment construction.

Should such a scenario arrive, and it looks like it will on recent evidence, it would be a welcome outcome when other sectors of the economy -- such as households -- are struggling to make the same contribution to growth as they have in the past.