Australia’s infamous housing shortage is at risk of quickly turning into a housing glut with our residential construction boom set to undermine price growth over the next couple of years. With population growth slowing and apartment buildings approved at a record rate -- it is only a matter of time before capital growth begins to ease.
Building approvals have increased by 18.5 per cent over the past year on a trend basis and, adjusted for population growth, it sits at around its highest level since 2000. This has been spurred on by unprecedented activity in the higher-density units segment, with high-rises sprouting up all over Melbourne and Sydney.
Over the past couple of years we have slowly seen these approvals translate into actual construction. The number of residential building commencements has increased by 13 per cent over the past year, while the number of completions rose by 20 per cent.
History tells us that approvals are not a perfect leading indicator of construction activity. Some projects fail to progress from the approval to the construction stage. The figures for completions have, for example, a standard deviation that is around 36 per cent and 30 per cent lower than approvals and commencements, respectively.
As a result, we can safely say that the residential construction boom will not be quite as large as that indicated by the approvals data. Completions will fall well short of that level and this should be factored into calculations of economic growth.
Nevertheless, the residential construction boom is significant by historical standards. We are building properties at the fastest rate since 2000 and that has important implications for the housing sector.
Australia is widely considered to have a severe housing shortage. It’s a fact that is rarely questioned -- at least not within conventional channels -- but it isn’t as clear cut as many might expect.
There have been periods over the past quarter century when Australia has had a housing shortage and periods in which we have arguably overbuilt. Since the onset of the global financial crisis we have mainly experienced the former; in the preceding decade we mostly experienced the latter.
It’s one of the reasons why dwelling price growth has been relatively volatile since the turn of the century. We have experienced three property downturns during that time -- despite a mining boom and favourable income growth -- and we have clearly set the scene for a fourth downturn over the next few years.
One way to measure housing supply dynamics is to deflate approvals or completions against population growth. This won’t determine whether we have a cumulative shortage or not, which is almost impossible to calculate, but it does help determine whether the shortage is increasing or not.
We know from the ABS that household size is roughly 2.5 people, which should, in theory, provide a useful cut-off for determining whether we are building too many properties.
Unfortunately, there is an important caveat to this discussion that isn’t directly observed and can only be estimated poorly. We need to remember that the net change in housing supply is not only determined by how many properties are built but also by how many we destroy.
Census figures indicate that completions data between census dates overestimate the net increase to the housing supply. Since the census is completed every five years and not released in a timely manner, we don’t have a good estimate of the number of properties destroyed until well after the fact.
Nevertheless, the completions-to-population ratio is still a fairly useful indicator, even if it is somewhat understated. The ratio fell to its lowest level in a decade during the March quarter and should fall further over the remainder of the year.
The underlying dynamics point to weaker price growth -- or alternatively an outright price decline -- over the next couple of years. Population growth continues to moderate, with net migration easing, while construction remains elevated.
Investors are banking on a housing shortage propping up prices but that may be misguided. Supply is now increasing more quickly than demand; perhaps more importantly though there is mounting evidence that demand has eased (An ominous sign for the property market, July 10).
Australia’s housing shortage isn’t a myth but it clearly isn’t as relevant to market dynamics as it has traditionally been since the onset of the GFC. As a result, unprecedented construction activity, particularly in Melbourne and Sydney, should put downward pressure on dwelling prices over the next couple of years. Investors would be wise to take account of these dynamics if they intend to enter an already overheated property sector.