Australia has had a housing construction boom in recent years. Most of this has come in the form of new apartments in the major cities.
This has generally been a positive story. With mining investment in a steep decline, having fallen by 63 percent since its peak in 2012, housing construction has helped to fill the gap. Given strong population growth and an extended period of weak housing construction when the mining boom was strong, Australia had needed to build more housing to meet demand.
Lack of housing affordability and comparatively high housing prices also partly reflect a lack of well-located housing in the major cities.
Five years on, the national housing undersupply is now close to being worked off. In Melbourne, Brisbane and Perth, there are some signs of an oversupply of apartments, although Sydney still appears to have an undersupplied unit market. The detached housing market does not appear to be over-supplied.
The housing construction boom is now near its peak. Building approvals have fallen sharply in recent months. Importantly, though, given the lag between approvals and completions –which has been elongated by the large number of high-rise apartment buildings under construction – and the large stock of work-yet-to-be-done on approved dwellings, we do not expect construction to start falling until late 2017.
Like ships passing each other in the night, we expect housing construction to start falling around the time that mining investment stops its decline. Australia’s investment outlook is then expected to be supported by mine maintenance and repair, infrastructure investment and the business investment needed to support services exports, such as tourism and education – Australia’s next growth engine.
Having added housing supply, we expect house price growth to slow in 2017. Oversupply of apartments in Melbourne and Brisbane could see price declines in those markets. However, having not built many detached houses in recent years, we think that any apartment market shake-out is unlikely to spill over to the detached market (Downunder Digest: Australia’s many housing markets in 2017, 25 November 2016).
Housing boom has been a key part of the rebalancing act
A housing construction boom, mostly driven by construction of new apartments in the major cities, has been a key element of the rebalancing act at the end of the mining boom. By cutting interest rates, over the past five years, the RBA has supported growth in housing construction, which has helped to offset the drag from falling mining investment and commodity prices. Housing investment, which was itself a drag on GDP growth of around -0.25ppts a year in 2012 and 2013, contributed around 0.4ppts a year in 2014, 2015 and 2016. This has partly offset the drag of around 1.25ppts a year on growth from falling mining investment in 2014-2016.
Approvals are falling, but there is still work yet to be done.
The residential building boom is now coming to its end. Building approvals have fallen by 15 percent since their recent peak in August 2016 (Chart 1).
The decline has been driven by weaker medium-density approvals, while detached house approvals have been steadier.
A decline at some point was, of course, inevitable. The residential building boom could not continue indefinitely, as it would eventually lead to an oversupply of housing. As it stands, there is some evidence that too many apartments may be being built in Melbourne, Brisbane and Perth, although supply is not likely to outstrip demand in Sydney in the near term.
For GDP, the fall in building approvals signals that housing investment will be a drag on GDP growth at some point. Historically, approvals have tended to lead housing investment by around 2-3 quarters.
However, given that the bulk of the building pipeline has been high-rise apartments, and that these take longer to build than detached houses, the lag between the fall in approvals and the decline in actual investment is likely to be longer than normal (Chart 3). As a result of the larger amount of high-rise apartments being constructed, there is a bigger than normal stock of work-yet-to-be done on dwellings that have already been approved.
With a large pipeline of work to be completed, we expect housing investment to rise further in coming quarters and make a solid contribution to GDP growth in the next few quarters, before falling from late 2017 onward.
Oversupply of apartments in some areas, but not of houses
The apartment building boom has generally been a positive story. When the mining investment boom was strong too few dwellings were being built to meet demand from strong population growth and Australia had accumulated a national undersupply of housing (Downunder Digest: Australia’s housing supply ramp-up, 9 September 2015). The undersupply of well-located housing has contributed to Australia’s comparatively high housing prices and low housingaffordability. The building boom has helped to work down this undersupply.
At a national level, on our estimates, the housing market should be back in demand/supply balance by the end of 2017 (Chart 7). Of course, these estimates are subject to considerable uncertainty given the many assumptions used to calculate them. The aggregate estimates also belie variations across the states. Although construction has been strong in Sydney, it has only just recently matched population growth, with accumulated undersupply in New South Wales still yet to be worked off (Chart 8). In contrast, Melbourne has had stronger construction for longer, implying that the Victorian market is already close to balance. In Queensland and Western Australia construction has outpaced population growth for some time now (Chart 9).
These trends help to explain the variation in housing price growth across states. Since the national price trough, in mid-2012, housing prices have risen by 69 percent in Sydney and are still rising at double-digit rates. In Brisbane, Adelaide and Perth, housing prices have risen by only 20 percent, 10 percent and 7 percent over that period, partly reflecting stronger supply relative to demand. The Melbourne market is a little more complicated, with detached house prices having risen by 55% over that period, but apartment prices only 19 percent higher.
We expect continued solid gains in detached house prices in Sydney and Melbourne in 2017, but possible price falls for apartments in Melbourne (see Downunder Digest: Australia’s many housing markets in 2017, 25 November 2016). For Brisbane, we also expect apartment price falls, while we expect further weak housing price gains in Adelaide and further price falls in Perth in 2017.
Implications for policymakers
For the macroeconomic cycle, the direct effect of the fall in housing investment, expected to be from late 2017 onwards, should be more than offset by the direct effect of the drag from mining investment disappearing, as Chart 6 shows. The indirect effects could be important though and present risks. Falling housing investment could weigh on employment in the construction industry. A shake-out in the apartment market could have a negative effect on consumer confidence and could drive a negative wealth effect.
We suspect these risks are manageable given that the bulk of the housing stock is detached dwellings, and see limited substitutability between the detached dwellings and inner-city apartments, in particular. We do not think the expected housing construction fall will be enough to motivate the RBA to cut its cash rate as we see the negatives are being outweighed by the impact of the expected stabilisation in the mining industry.
For fiscal authorities, the boost to housing supply should be going some way to help improve housing affordability. Expected falls in housing prices in Perth and some parts of Melbourne and Brisbane should improve affordability in those markets, by definition. More effort is likely to be needed to improve housing affordability in Sydney and in the detached house market in Melbourne.
Policymakers ought to have a keen focus on improving urban infrastructure in these markets as it would help to improve housing affordability, support productivity growth and growth in services exports, which we see as Australia’s next growth engine.
PAUL BLOXHAM IS CHIEF ECONOMIST (AUSTRALIA AND NEW ZEALAND) FOR HSBC.