The Housing Construction Boom is a Ticking Time Bomb

Despite a peak in approvals, housing construction is set to rise across Australia over the next 18 months. Over 200,000 new homes are expected to come online, according to a new Housing Industry Association report. To put this in context, it ensures construction will grow at the second fastest level on record…But why?

There are emerging signs the housing market has already peaked. Banking measures taken to curb investor growth have hit particularly. More recently, a similar crackdown on owner occupiers is adding further pressure on demand. The big banks all lifted mortgage rates for owner occupied loans.

The effects of regulations aimed at investors took a while to kick in. APRA first instructed banks to limit investor lending to 10% back in 2014. But it wasn’t until the middle of this year that we saw evidence of the measures working.

In response, owner occupier loans grew as the rate that investor loans dried up. But over the next few months, we’ll likely see clearer signs of slowing lending among owner occupiers too. And yet…construction is on the rise.

Considering the present state of the market, why are 200,000 new homes slated for construction?

In all likelihood, we’re seeing a lag effect take place within the market. Signs the market was peaking only became apparent in August. It would make sense if a good portion of these building approvals came prior.

If that’s the case, this new supply of housing may hurt the market in the long run. It’s likely to speed up the extent of a market downturn. And it might even facilitate a wider economic crash.

There are two ways to look at this. On the one hand, it could be a positive development for the economy in the short term. Housing construction remains an important driver of economic activity. The sector accounts for 7.8% of Australia’s GDP. In fact, construction is seen as a key pillar in offsetting the effects of the mining downturn.

But a bigger concern is what this might do to house prices. And what a wider price decline means for the rest of the economy.

There’s a strong link between falling prices and the health of the economy. I’ve listed some of the key factors in this relationship below:

  1. It affects household wealth. As prices fall, it drags on consumer confidence. Households are less likely to spend, or take on more risky borrowing.
  2. It reduces a home’s equity. Falling prices ensure that households can’t use their homes equity to finance other spending. Again, this has the effect of slowing consumer spending.
  3. It affects the perception of the economy. When the market undergoes price falls, it reflects badly on the economy. People start getting jittery about the state of the economy. Rightly so, considering the importance of property in Australia. If people believe prices will drop, then they’ll put off buying property. If nothing else, that serves to push even more downward pressure on prices.

Housing decline is already well underway

We know by now that a slowdown in house price growth is gaining momentum.

The property market in Perth remains a mess, with prices plunging 2.8% in October. Brisbane also fell by a modest 0.2% last month.

The big two markets, Sydney and Melbourne, had an equally poor month. Dwelling prices in Sydney rose just 0.3%. During the October quarter, prices in the harbour city grew at just 1.5%. Keep in mind that in the year to June Sydney’s market grew at almost 18% year on year. At 1.5%, the market saw a steep decline in quarterly YOY growth. Melbourne prices, meanwhile, outpaced Sydney in October. Yet they still only rose by 0.6%, indicating that a ceiling isn’t far away.

As it happens, most of this new construction is set to take place around Sydney and Melbourne.

In New South Wales, housing construction is likely to grow by 7.1% this year. In Victoria, housing construction grew by 26.6% last year. The state built 65,000 new homes. According to HIA, both NSW and Victoria will see construction fall over the next two years. By HIA estimates, both will see roughly 44,000 new homes built in 2017–18.

Yet any kind of growth is a problem from the perspective of supply. Slowing construction growth in preferable to rising growth. But it’s still growth in a market that doesn’t necessarily need it.

When house price growth slows, what you don’t want is more supply. All that does it risk adding further downward pressure on prices. And, as we’ve seen, falling prices are a pitfall for the wider economy.

Housing construction boom won’t help rental yields

Another issue with this construction boom is how it affects rental yields next year and beyond. How many of these homes will be investment properties? And how many will be owner occupied ones? It’s too early to tell.

But the lending crackdown is now hitting both investors and owner occupiers. Owner occupiers can’t account for all that demand. There are simply too many homes being built. So what will that do to already struggling rental yields? In October yields dropped to record lows. From a high of 4.2% in 2012, rental yields fell to 3.4% across the nation. CoreLogic RP reports:

Gross rental yields at record lows and affordability constraints are acting as a further disincentive [for investment], particularly in Sydney where the median unit price is equal to, or higher than, the median house price in every other capital city.

Rental yields in Sydney are at 3.3%. In Melbourne they’re at 3%. These two markets have the lowest gross yields in the country.

This will lower demand for investment properties. We can’t expect owner occupiers to account for 200,000 homes. The market will have to share the load. Yet there’s less incentive for investing than there’s ever been. Loans are less affordable, and rental yields are sliding. Relying on capital gains is a non-starter too. Slowing house price growth makes negative gearing a risky strategy.

The construction boom over the next 18 month is residue left over from the housing boom. In all likelihood, it will leave the market badly oversupplied in the coming years. That won’t leave much upside for the future of house prices.

Worst of all, it could set the stage for a wider economic crash.

Mat Spasic,

Contributor, Markets and Money

PS: Not everyone at Markets and Money is pessimistic about the housing market. Our property expert, Phillip J. Anderson, remains bullish on the market’s outlook. He’s maintained all year that house prices are set to boom over the next decade.

If you’re worried about potential property bubbles, Phil’s report is a timely remind that nothing is set in stone. Phil’s 20 years of experience as a property analyst and advisor has given him a keen sense for where the property market is, and where it’s going. He predicted a housing market crash in 2008. He also went against the mainstream in 2009, saying house prices would go on to boom this decade.

He was right on both accounts.

In a free report ‘Why Australian Property is on the Verge of a Decade Long Boom’, Phil guides you through this coming decade. He’ll show you the right time to buy property at its cheapest, and how you can use this to time your investments. To find out how to download his free report, click here.

Markets and Money offers an independent and critical perspective on the Australian and global investment markets. Slightly offbeat and far from institutional, Markets and Money delivers you straight-forward, humorous, and useful investment insights from a world wide network of analysts, contrarians, and successful investors.

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