Building approvals remain elevated but there is tentative evidence that they are either at or near their peak.
Nevertheless, the residential construction boom is set to contribute solidly to real GDP growth over the remainder of the year and is expected to provide some support next year.
Building approvals rose by 2.4 per cent in May, beating market expectations, to be 17.6 per cent higher over the year. The monthly figures are often extremely volatile owing to the higher density segment, and therefore the data should be treated with a degree of caution.
Typically I prefer to analyse the trend estimates, which offer a more accurate assessment of market conditions. On a trend basis, approvals were broadly unchanged in May and are now 18.5 per cent higher over the year. Approvals have eased modestly from their peak but remain at an elevated level by historical standards.
We remain firmly in the midst of a clear shift in the urban composition of our three largest cities. Whether it’s a reflection of elevated prices necessitating a shift towards a smaller living space or changing preferences, Australia -- once characterised by its suburban sprawl -- has embraced the shoebox apartments that now dominate skylines in our biggest cities.
The key question (and one not easily answered) is whether property developers have gone too far. Are they building too many apartment buildings, particularly high rises, near the CBD in Sydney and Melbourne?
Approvals for private units jumped by 16.5 per cent in May, offsetting a 17 per cent fall the previous month, to be 46 per cent higher over the year. The trend estimates suggest that approvals for apartment buildings may have already peaked.
The higher-density segment now accounts for almost half of all building approvals, which makes this residential construction boom somewhat unique by historical standards. The risk of an overbuild is considerable, particularly given the long lead times associated with high-rise projects.
Property developers are making a sizable bet that the property market remains healthy over the next couple of years. With the property sector already operating in uncharted waters -- with regards to investor activity and price multiples -- several developers should be growing nervous about any new projects that have yet to begin.
Finally, there is a need to provide some historical context for the current residential construction boom. I have already established that it’s unique in the sense that we have never seen a boom of this nature in high-rise developments. But the past still provides an important insight into how this episode may play out.
Until recently, the current episode appeared to be similar in size and scope to the 2010-11 construction boom. Now it appears to have similar characteristics to the boom in the late 1990s.
New residential construction accounted for just 3.4 per cent of real GDP in the March quarter and is unlikely to reach 4 per cent before the boom begins to ease. If it does, then it will probably have more to do with weakness across the broader economy than the construction sector itself.
A construction boom originating in the higher-density segment will take longer to evolve and therefore activity and the employment response will likely be spread over a longer period. The month-to-month rise in employment and quarter-to-quarter rise in construction may be weaker than during previous construction episodes but on the flipside it will prove to be more persistent.
Dynamics within the construction sector will be an important indicator in assessing an economic transition that so far isn’t travelling as smoothly as policymakers would have preferred. Building approvals are an important part of this narrative and the pace of decline from this point -- assuming the market has peaked -- will provide a leading indicator as to the degree of support likely to be offered by residential construction next year.
Nevertheless, there is a non-trivial risk that residential construction may have peaked before the toughest segment of the mining investment collapse arrives. If that eventuates, then we could be faced with a simultaneous collapse in mining investment and a more moderate decline in residential construction activity.