Residential Building is Not About to Crash

 Despite the fall in approvals the pipeline of work remains high

Because of the housing crisis there was a lot of attention given to the 5.8% fall in Australian residential building approvals for housing over the year to February 2024, the most recent data. Approvals for other residential (medium and high rise buildings) are now down to around half the level of 2022, while approvals for houses have declined by much less, around 15%. 

 

On the surface, these declining approvals look like a problem for residential building in the future, but this is not the case because of the backlog of work that has accumulated over the last few years. The combined value of work yet to be done on projects already commenced and the value of work on projects approved but not yet started is known as the ‘pipeline’ of future work.

 

In June 2023 there was $56 billion of residential building work yet to be done, a record amount, and in December it was $53bn. As Figure 1 shows, the value of work yet to be done on detached houses fell from $24bn to $21bn in 2023 and fell on other residential (medium and high rise buildings) from $33bn to $31bn. This slight slowdown in the value of work yet to be done reflects the 6.4% decline in commencements between December 2022 and December 2023, but does not change the fact that there were 226,035 dwellings under construction in December 2023 compared to 237,684 in December 2022. The value of residential work done only fell by 1.5% in the year to December 2023, and is still at a very high level. 

 

 

Figure 1. The value of work remaining to be done on jobs under construction 

 Source: ABS Building Activity, seasonally adjusted chain volume measures. 

 

 

The fall in the value of work yet to be done has been offset by increases in the value of work on projects approved but not yet started. Between December 2022 and December 2023 this increased from $5bn to $6bn for houses and, after falling to $10bn, was back at $11bn for other residential. In December 2023 the value of work on projects approved but not yet started was at a record level of $17.8bn. While some of these projects will not get built, for the great majority the question is when not whether they will be started. 

 

 

Figure 2. Value of work on projects approved but not yet started.

Source: ABS Building Activity, seasonally adjusted chain volume measures. 

 

 

When the value of work yet to be done on projects already commenced and the value of work on projects approved but not yet started is combined into the ‘pipeline’ of future work, the total in December 2023 was $70.6bn, slightly down from the record $72bn in December 2022. This is well above the previous record high of $58bn reached in 2018, and the result of sustained increases since the low of $44bn in 2020. 

 

 

Figure 3. Total value of work in the pipeline

Source: ABS Building Activity, seasonally adjusted chain volume measures. 

 

 

Why has the pipeline of work grown so fast and become so large? 

 

Despite the increase in interest rates since 2022 house prices have increased and the value of residential work done has barely changed. Monetary policy in Australia targets residential building because decreased consumer spending due to increased interest on residential mortgages is the RBA’s primary means of reducing inflation. Higher interest rates reduce the number of potential buyers of new homes so developers reduce project commencements, which have declined but not by much. However, developers continue making applications for development approval on sites they own because the outcome and time these will take is uncertain, and an approval is an option that can be exercised in the future. This increases the amount of work to be done on projects not yet started, and the cost of those projects is rising due to inflation. 

 

A second reason is the recent large increases in non-residential building and engineering construction, and the resulting competition for resources. The value of non-residential work done increased by 12% and engineering by 17% in the year to December 2023. Although the exchange of workers between industry sectors is limited, key trades like electricians and materials like concrete are both shared and finite, and non-residential construction will often be prepared to pay more for labour and materials than residential work. In particular, the increase in non-residential building from $12.8bn in December 2021 to $14.6bn in December 2023 (Figure 4) countered the decline in residential building so the total volume of building work has not fallen. 

 

Figure 4. Total construction

 

 Source: ABS Construction Work Done, chain volume measures.

 

A third, related, reason is the shortage of workers to complete the projects already started. The ABS had 1,229.8 million people employed in construction in December 2023, an increase of 0.0% since December 2022. Reallocation of workers between industries is typically small, not much more than a couple of percent of total employment a year, and tens of thousands of workers can't move from retailing to construction quickly or easily. More and better training opportunities would be one way to help solve the industry’s problems, as would higher retention rates for apprentices. 

 

According to the ABS, unemployment is historically low at 3.8% of the workforce, as is the underemployment rate of 6.5%. In March 2024 the participation rate was 66.6%, monthly hours worked increased, full-time employment increased to 9.9 million and part-time employment was 4.4 million people. The pool of available labour is small, there were 573,000 unemployed people in March, and the question of where more workers will come from has few possible answers: maybe early retirees would return to work with better working conditions; reducing hospital waiting lists might get people back to work; higher immigration favouring trades cuts both ways by increasing demand for housing. 

 

Finally, hundreds of building companies and professional services firms have failed over the last few years (Figure 5). How much impact insolvencies have on residential commencements and completions is hard to know, but there has to some effect as affected projects can be delayed by contract renegotiations, suppliers not being paid, and clients having to refinance the work. How many projects have been affected is also unknown, but the cumulative number of dwellings would be in the thousands, and incomplete projects are sitting in the pipeline. 

 

Figure 5. Insolvencies

 

Source: RBA Financial Stability Review – March 2024

 

 

Conclusion

 

The decline in approvals for residential other building has been significant, but has been much smaller for detached houses. However, although total residential building approvals have fallen to around half their level in 2022, the value of work in the pipeline for projects under construction and yet to be started has not, and is currently close to $71bn, just below the record high of $72bn at the end of 2022. 

 

Residential commencements in 2023 were only down by 6.4% on 2002, therefore expected completions in 2024 will not be much below the 2023 level of 172,725 dwellings. During 2021-23 between 40 and 45,000 dwellings have been completed each quarter, which may be less than the 50,000 plus quarterly completions between 2016-19 but is still close to the industry’s capacity to deliver new housing. 

 

Residential building capacity has been affected by the increase in non-residential building work, as the total volume of building work done is now at a historically high level. The limited supply of materials and availability of workers will reduce the number of residential building commencements and increase the time taken for completions. This will have the effect of keeping the value of work in the pipeline high through 2025, and probably further into the future as approvals increase from their current low level. 

 

Therefore, the good news is that residential building is unlikely to significantly decline in the near future, despite the recent fall in approvals. That level of expected completions, however, is well below the number required to meet the housing targets of the Commonwealth and State governments. The bad news is that it is hard to see how the supply of new housing can be increased in the short term, given the increase in non-residential building and public sector engineering construction. At these levels, the amount of work in progress is increasing the time taken to complete projects due to limits on the availability of workers and supply constraints.