The rise in interest rates and construction costs is holding back recovery in Australia’s home building market notwithstanding that underlying demand for new housing remains strong, a leading housing market economist says.

Speaking at an industry outlook breakfast held in Melbourne, Housing Industry Association Senior Economist Tom Devitt said that strong underlying demand for new housing construction is being driven by several factors (see below).

However, he said that new home building activity is being held back by higher interest rates and higher construction costs.

“The demand for housing is definitely there,” Devitt said.

“There is an acute housing shortage and strong population growth.

“The capacity of buyers to get back in the market is there. There are lots of jobs, savings and assets and very few mortgage defaults. The financial sector is in good shape.

“And the industry has the medium-term capacity to build over 200,000 homes per year.

“Unfortunately, the rate at which new work is currently entering the pipeline in detached and multi-unit work remains so weak at decade lows because of construction costs.

They (higher costs) are undermining the viability of projects for builders and the affordability of those projects for buyers.

“First and foremast, after more than two years (since interest rate increases began), this is still the steepest rate hiking cycle from the Reserve Bank in a generation since before the 1990s recession. This is clearly going to limit the buying power of the average would-be home buyer and the average would-be builder.

“The surge in borrowing costs have compounded the cost of construction which had already surged during the pandemic”

Devitt’s comments follow last month’s release of the latest quarterly edition of HIA’s National Outlook report.

In its report, HIA says that the recovery in commencements which had been expected to occur in 2024 would no longer occur as an anticipated recovery in multi-unit residential approvals is yet to take hold.

Instead, HIA is forecasting commencements across the current financial year of 159,730 – the lowest level of housing starts in twelve years.

Going forward, HIA expects that commencements will increase by 10 percent in 2024/25 but remain at historically low levels of 176,050.

It is not until 2025/26 that a significant recovery is expected to see annual housing start numbers rise back above 200,000.

The forecasts come as building approvals – a leading indicator of detached house starts – have been on a downward trend so far this year and remain stuck at levels which are near decade lows.

Concerningly, mutli-unit approvals have been falling so far in 2024. This is concerning as the multi-unit sector is expected to be the first to recover following the detached house construction boom which occurred during COVID.

According to Devitt, underlying demand for new housing remains strong.

This is being driven by:

• continued strong net overseas migration even as this returns to normal levels after a recent ‘catchup’ surge following COVID
• a massive undersupply of existing housing as shown by rental vacancy rates which are either around or below 1 percent across most capital cities (a vacancy rate of 3 percent is considered to be ideal in a well-balanced market)
• continued low unemployment at least for now – meaning that that many households still have the ability to repay mortgages notwithstanding that mortgage rates have increased
• high savings rates and low mortgage defaults; and
• healthy capital ratios being held by banks.

However, Devitt says that the effect of this is being offset by higher mortgage rates and higher construction costs.

Regarding mortgage rates, official interest rates have increased from 0.1 percent in April 2022 to 4.35 percent in June 2024 – the steepest increase in rates since the late 1980s.

On construction costs, Producer Price Index data from the Australian Bureau of Statistics indicates that housing construction costs (excluding land costs) increased by 40.1 percent over the four years from March 2020 until March 2024.

In particular, according to Devitt, since the beginning of the pandemic:

• building product prices are up by around one-third despite having recently stablised
• fuel prices have increased by around 50 percent
• prices for key trades have increased by about one third (and are currently increasing by around six percent – about three times higher compared with pre-pandemic averages of around two percent); and
• land prices have risen by around one-third (and price pressures are reemerging in some markets despite sales volumes remaining low).

Furthermore, Devitt says that other factors are also contributing to the delay in new home building recovery.

These include low retail sales and consumer confidence, a decline in real wages, double digit rental price growth a delay in the first expected interest rate cut (which HIA now does not expect until next year), surging numbers of builder collapses and persistent construction labour shortages as migration has thus far focused around students.

Better News in Established Home Renovations

Outside of new housing, the picture is slightly more encouraging in terms of existing home renovations.

Whilst the COVID related boom in home renovations activity is over, Devitt says that HIA believes there has been a permanent step up in terms of housing renovations activity even as activity levels have fallen back to the point of underlying demand following the previous HomeBuilder surge.

Indeed, HIA expects that renovations activity will be higher compared with any other time prior to COVID for the duration of HIA’s forecast period.

He says key activity drivers include greater desire for space, affordability constraints in the current housing market (which make renovation a more attractive option compared with buying or building a new home) and greater levels of home equity on account of higher dwelling values.

Policy Change Needed to Hit Housing Targets

According to Devitt, significant policy action is needed if Australia is to achieve its target of delivering 1.2 million homes in well-located areas over the five years from 1 July 2024.

As things stand, he says that the nation is expected to fall short of the target by around 200,000 homes.

He says action is needed in several areas.

In the short term, Devitt says this includes easing monetary policy (when appropriate), easing restrictions on bank lending for the purchase or building of new homes, suitable tax and stamp duty concessions and the deferral of new building code.

In the medium and longer term, it involves planning to enable greater density, unlocking sufficient quantities of suitable land for new housing development, skills and workforce development and suitable infrastructure to facilitate new housing delivery.

He says the importance of reform – particularly to bring costs down – should not be underestimated.

“The choice is either to just wait potentially a few years for household incomes to catch up to these elevated costs of construction, planning and compliance whilst people struggle to afford housing or costs need to bought down in some other to catalyse a stronger recovery in new home building and make housing more affordable sooner,” Devitt said.

The industry outlook breakfast was delivered in partnership with Cosentino.

Major partners included Six Star Plus, Weathertex and Origin whilst supporting partners include Clipsal, HIA Insurance Services and Panasonic HVAC Solutions.