The end of Australia’s residential construction boom is close at hand as the number of building approvals begins to deteriorate. Residential construction will support economic growth through to the end of the year but will become a drag on growth next year as building activity eases.
Building approvals fell by 6.9 per cent in August, missing market expectations, to be 5.1 per cent higher over the year. Recent monthly data has been exceptionally volatile owing to the higher-density apartments sector, and August was no exception.
On a trend basis -- a more reliable indicator for future construction activity -- approvals declined by 0.7 per cent in July and is now 2.9 per cent below its peak earlier this year. Approvals have declined for five consecutive months.
Much of this recent weakness has been driven by apartments, which have fallen 4.7 per cent from its peak earlier this year. Approvals for houses has been relatively stable over the past year.
Growth over the past few years has been quite remarkable in an historical context. The downside to such rapid growth is that the downturn is usually remarkable as well.
Some analysts are concerned that property developers are building too many high-rise buildings across the inner-city in both Melbourne and Sydney. Such fears are not without justification, particularly given the easing of population growth across both cities (A key engine of economic growth is sputtering, September 25).
Property developers are betting that the property market will remain healthy over the next couple of years. It’s a risky strategy given the combination of weak income growth and new housing supply; not to mention recent regulatory intervention by APRA into investor lending.
Recent weakness has been driven mainly by Victoria. New South Wales is the only state where approvals continue to rise on a trend basis. Activity in Queensland and Western Australia should fall further as mining investment contracts.
The Reserve Bank has placed great faith in residential construction to partly offset the fall in mining investment. Residential construction has responded strongly to lower interest rates, due in part to rapidly rising prices in Sydney and Melbourne.
However, it appears as though residential construction picked up too soon and too quickly. It provided a considerable support for the economy in the early stages of the investment collapse but could conceivably collapse itself before mining investment stabilises.
Based on the historical relationship between building approvals and completions, I estimate the completions should rise by a further 10 per cent from their level in the March quarter. Any collapse will occur next year -- possibly beginning in the June quarter.
This means that Australia’s economic transition will rely predominantly on household consumption and net exports. We can safely put a line through non-mining investment at this point, although hopefully a weaker Australian dollar will begin to make inroads at some point.
Net exports could come under some pressure due to weaker-than-expected Chinese growth. Nevertheless, with more iron ore production set to come online and the LNG sector shifting from the investment to the production stage, export volumes should rise at a fairly solid pace over the next couple of years.
Nevertheless, export revenues are set to fall further over the next couple of years as the increase in volumes proves insufficient to offset weaker commodity prices. Weaker-than-expected demand from China will also weigh on prices to some extent.
Aspects of this narrative may change over the next couple of years. The dollar, for example, could crash through the US60c level and provide much needed stimulus to our exports sector, leading to a stronger than expected boost to production and employment.
Further rate cuts could also free up household and business balance sheets and allow them to invest more and take advantage of stronger asset prices. Regulatory intervention by APRA could direct more capital towards the business sector.
But we can safely say that residential construction won’t be part of that equation. Even if our economy successfully rebalances -- by which I mean we avoid a recession and the unemployment rate begins to fall -- it won’t be achieved with the help of residential construction. Unfortunately, construction activity has almost peaked and when it does it will experience a swift decline.