Here comes Australia's (apartment) construction boom

There has been a lot of lively debate about Australia's housing markets over the past decade, and I make no apologies for having situated myself towards the bullish end of the spectrum for most of that time.

I was never in agreement with the crash predictions before, during or immediately after the financial crisis, largely due to supply-related issues and falling interest rates.

Then there were claims that credit growth would not be able to see prices rebound, instead seeing prices melt away - that didn't fit with my (perhaps old school) view that property prices cycle and would be more likely to pick up again when interest rates fell.

But what about the residential construction boom? 

The pessimistic view over recent years has been that land prices would be too high and therefore could not allow a construction recovery to replace the fading mining construction.

My own view has been there certainly would be a construction recovery since low interest rates (and the associated ease of financing) and rising dwelling prices would make it so. Developers tend to need rising prices and reasonable financing costs to become incentivised to build.

As will be considered, the actual answer to the riddle, as is so often the case, appears likely to lie somewhere betwixt and between the two extremes.

Dwelling units commenced 

Recent data showed building activity which runs to December 2013 to be still relatively sedate.

However, building activity to December 2013 is retrospective data.

What we're really interested in is what is in the pipeline, which is shown by the dwelling units commenced figures.

What the data showed is that Australia's residential construction is now firmly on track...but...it's almost exclusively being driven by a massive increase in the number of units and apartments being built.

As you can see, apartments and units now account for more than four in every 10 new dwellings being built, which represents a huge structural shift on what we have seen in decades gone by.

This is particularly so, as you might expect, in cities such as Sydney, Melbourne and Darwin where desirable land made available for development has been scarce.

In seasonally adjusted terms, the number of dwelling commencements increased by 8.2% in the three months to December, with multi-unit commencements increasing by a whopping 21.3% in the quarter. 

The rolling annualised number of apartments and units commenced in the December quarter therefore hit an all-time record high, and I wouldn't mind a bet that a new record high is recorded in the March 2014 quarter too.

Since the September 2009 quarter, the rolling number of apartments and units commenced has nearly doubled, showing a massive increase in starts of 96%.

The key takeaway is that Australia's apartment construction boom is underway.

A few observations 

Firstly, the level of dwelling construction is now clearly set to boom, following on from the building approvals data which has soared to decade highs.

This is great news for the Australian economy, and the construction is certainly needed.

When adjusted for the boom in population growth, dwelling unit commencement figures have actually been declining in relative terms over the last few decades adding to the upwards pressure on dwelling prices.

However, apartment construction in itself is unlikely to plug the hole left by the mining boom, since the construction value per dwelling is clearly lower for apartments and units than it is for detached houses. 

The Reserve Bank will certainly need other sectors of the economy such as commodity exports and retail sales to do their share of the lifting, and therefore the cash rate may not be adjusted upwards towards a normalised level for a little while yet.

Thus, while futures markets have priced out further interest rate cuts (and even Bill Evans and Westpac have given up the ghost on forecasting any more cuts), on balance market are not yet expecting to see a hike until some time in the middle of 2015.

Given that there is a lag in the effects and outcomes of monetary policy and that multi-unit dwellings can take two to three years to come online, I believe that this apartment construction boom is one which could run and run over the few years ahead.

For this reason, budding property investors need to be very savvy about what property types they buy and where.

State by state thoughts 

The final observation is that the apartment commencement data is very uneven by state.

This little snippet of data provides one small clue as to why as an property investor, I favour Sydney over Melbourne.

Very strong data was recorded for Queensland dwelling commencements (+15.8% quarter on quarter) and especially South Australia (+25.2% quarter on quarter) where dwelling commencements were pulled forward due to the Housing Construction Grant.

On the other hand dwelling commencements fell in Canberra/ACT (-13.3%), Tasmania (-12.6%), Western Australia (-1.3%) and Northern Territory (-26.6%).

Perhaps surprisingly, New South Wales showed a pick-up of only 2.8% in the quarter (although from a high-ish base) yet Victoria showed a monster pick-up in multi-unit commencements of 33%.

This little snippet of data provides one small clue as to why as an property investor, I favour Sydney over Melbourne.

Both cities have fantastic fundamental attributes for investors, including vast ongoing population growth and diverse employment markets.

But Sydney has one key difference, being the artificial supply constraints due to its geographical footing.

Since Greater Sydney is enclosed by the Blue Mountains, national parks and an ocean, the only realistic direction for us to build significantly more dwellings is upwards.

Unfortunately, gaining approval to build larger multi-unit dwellings in desirable locations is devilishly difficult, as objections are sure to be raised at every step in the process.

We have seen this week that Parramatta's new 90 storey Aspire tower will include 700 apartments and will be the tallest residential tower in the southern hemisphere - at a monstrous 336 metres this will even surpasss the truly awesome Q1 tower up on the Goldie - which provides another clue to how the Sydney of tomorrow will look.

That is, that there will be certain hubs and business districts with Manhattan-style tower block accommodation.

The land value per dwelling in these developments is very low at just a few percent, the new apartments are very expensive, and personally I would steer well clear.

Instead, investors should look at the well-established boutique apartment blocks with materially higher land value content (50-60%+), where NIMBY-ism and planning restrictions will keep the new supply permanently restricted to an absolute minimum.

You can visit AllenWargent property buyers (London, Sydney) or Pete's blog.

His new book 'Four Green Houses and a Red Hotel' is out now.