Building solid foundations: Insights into the housing industry

Home ownership is the cornerstone of the great Australian dream, as it can provide financial and emotional security for households and typically represents their largest lifetime investment.

Housing investment also plays a vital role within the economy, as it can influence the pace of general economic growth, while providing an important fiscal and monetary policy nexus between governments and households.

The residential building market comprises the construction of new single-unit (detached) housing (principally built by firms in the industry), new multi-unit apartments and townhouses, and alterations and additions to existing dwellings (i.e. home improvements). The value of total work done on residential buildings was about $49.3 billion in 2011-12, which represents flat growth over the past five years (0% per annum), while the value of work done on new single-unit housing construction has contracted by an average 1.5% per annum to currently total $26.8 billion (down 1.5% on the previous year). The number of single-unit housing commencements totals about 97,000 in 2011-12, down by 13.5% on the recent cyclical peak at 112,141 units in 2009-10.

The industry generates about 75% of its annual revenue from building work on new single-unit housing, about 7.5% from the construction of apartments and townhouses, 15% from alterations, additions and repairs to existing dwellings (i.e. home improvements) and the balance from speculative property sales (about 2.5%).

Total House Construction industry revenue is about $30.3 billion in 2011-12, down 2.3% from the previous year and representing a decline by 1.5% per annum over the past five years (matching the trends in total investment). Industry value added currently totals $8.33 billion, or 0.7% of Australia's GDP.

Housing investment trends were subdued during the mid- to late 2000s by the combined influence of weaker general economic conditions, deteriorating affordability and the tightening lending arrangements associated with the global financial crisis and the collapse of the US subprime mortgage market. The underlying demand for new housing has been supported by accelerated net population growth, which has exceeded 400,000 people annually over recent years.

House building activity in southern Queensland and northern Victoria was interrupted by the devastating floods of January 2011. The initial impact of the floods resulted in delayed work on current construction projects caused by flood damage to partly constructed housing and materials, and the diversion of skilled tradespeople to work in the severely affected areas where they could help homeowners.

Early in the next five years, the reconstruction work following the floods, coupled with strong underlying demand for new housing, will support further cyclical expansion in the industry's performance ahead of a minor correction in the longer term. The industry is forecast to maintain cyclical revenue growth averaging 3.5% per annum over the five years through 2016-17 to reach a record $36 billion, matching the pace of GDP growth (3.4% per annum).

Total direct employment by this industry is about 90,000 people in 2011-12, although the industry has a heavy reliance on a subcontracted labour force. The total industry workforce currently numbers about 300,000 to 350,000 full-time equivalent people. Wage costs absorb about 15% of annual industry revenue, while payments to subcontractors and employment agencies and for professional and technical services absorb about 35% of industry revenue.

The industry comprises about 35,000 establishments and is characterised by its many small to medium-size contractors, which operate in relatively narrow regional markets. The four largest contractors generate less than 10% of annual industry revenue and construct about 10% of annual commencements. Australia's leading homebuilders include BGC (Australia), Mirvac Group, Dale Alcock Homes, Henley Arch, AV Jennings, Metricon Homes and Devine Limited, each accounting for about 1.0% to 2.5% of the annual industry revenue and housing starts.

Industry outlook

Pent-up demand for new housing stemming from the recent surge in Australia's population, coupled with solid general economic performance, will underpin record housing construction activity over the next few years. However, a minor cyclical correction in demand conditions is expected late in the period as housing affordability deteriorates and some of the current demand is satisfied.

Divergent trends will appear in the housing market over the next five years. Investment is currently constrained by the price of entry into the housing market, by high levels of household debt and steadily rising mortgage interest rates. In addition, the lending practices of mortgage initiators tightened in the aftermath of the subprime market fallout in the United States and the global financial crisis. On the other hand, Australia weathered the global economic storm better than most countries. Households continue to have a capacity to take on debt, household savings are climbing and there has been an unprecedented surge of population, which puts upward pressure on housing demand. IBISWorld forecasts renewed cyclical growth in new housing construction with record levels of housing starts and investment.

Housing Construction industry revenue is forecast to average growth of 3.5% per annum over the five years through 2016-17, matching the investment trend in the single-unit housing market, and the projected pace of Australia's GDP growth (3.4% per annum). Annual industry revenue is forecast to average $35.5 billion per annum over the five years through 2016-17, or 10.6% above the average of $32.1 billion per annum for the previous five years through 2011-12. The number of single-unit housing commencements will climb by an average 2.5% per annum over the next five years.

Australia has high pent-up underlying demand for accommodation, particularly among first home buyers, stemming mainly from the unprecedented growth in the resident population over recent years (natural and immigration), which has fuelled rental yields and property values and lifted the underlying demand for new housing construction. The effect of escalating land values and material prices will cause housing demand to swing towards the construction of multi-unit apartments and townhouses, particularly for first home buyers and empty nesters who seek the lifestyles of inner-urban locations.

Investment by first home buyers in single-unit housing will be concentrated in new housing subdivisions in the outer fringes of metropolitan areas, and all the state governments have moved to open up land for residential development.

Reconstruction after the floods

The industry will continue to derive additional impetus from the reconstruction of housing in southern Queensland and northern Victoria in the aftermath of the 2011 floods. The total value of housing construction, repairs and renovations will be $4.0 and $5.0 billion, which includes about $2.2 billion for the reconstruction of single-unit houses (spread over the three and half years to 2015) and about $1.4 billion on renovations and repairs undertaken by this industry.

The reconstruction experience of New Orleans in the United States, following Hurricane Katrina in 2005, suggests delays in new construction activity will stem from a combination of disputed insurance payouts, bureaucratic red tape (e.g. building approvals on flood zone and relief payments), bottlenecks due to shortages in materials and skilled labour, and changed zoning and building codes in response to floods.

Tradespeople will be attracted to the flood-affected regions by higher contract rates, which will have a knock-on effect for the rest of the country. In the near term, the more remote regions of northern Victoria and central Queensland will face escalating construction costs and delays due to materials shortages.

Profit performance

The industry's profit performance is forecast to continue to strengthen considerably over the next five years, and is likely to be strongest for the larger-scale builders that combine construction with land development activities (particularly lifestyle community developments) and those servicing the reconstruction effort.

Industry gross operating surplus is forecast to climb by an average 6.0% per annum over the five years through 2016-17, increasing to about a 15% share of industry revenue, up from 12.5% currently. The improved profitability is expected to support growth in industry value added averaging 4.0% per annum over the next five years, and industry wage costs are projected to grow by 2.5% per annum, reflecting the growth in direct employment (1.5% per annum) and higher real wage rates, as demand conditions tighten in the skilled labour market (particularly in Western Australia and Queensland).

Housing investment rebounds

The pent-up underlying demand for owned and rental accommodation, fuelled by population growth exceeding 400,000 per annum since the late 2000s, and the stabilisation of mortgage interest rates, points to the substantial upswing in total housing investment over the next few years. Improved general economic conditions should support housing investment trends and GDP is projected to climb by 3.5% to 4.0% per annum over the next three years to 2014-15, generating similar growth in household income.

Although housing affordability conditions remain generally unfavourable, with particularly high serviced land values, the First Home Owner Grant still applies (distributed by state and territory governments) and most states also provide generous subsidies for newly constructed dwellings, regional housing incentives and stamp duty relief.

The value of new single-unit housing construction will climb by 7.0% to 8.0% per annum over the two years to 2013-14, maintaining solid growth of 3.0% to 4.0% per annum over the next two years to total a record $33.5 billion by 2015-16. The number of single-unit housing starts will climb commensurately with accelerated growth in the short term, eventually reaching a cyclical peak at 115,250 dwelling units in 2015-16, or about 19% above its current cyclical trough (and about 3.0% above the previous cyclical peak in 2009-10).

The upswing of investment will cause industry revenue to surge by 7.3% per annum over the next two years, before moderating through the mid-term, reaching a record $37.5 billion by 2015-16 (23.8% above its current level). This performance will fuel robust growth in operating profit and will lift direct employment by 8,500 people over four years (about 2.0% per annum) to peak at 97,000 people in 36,250 establishments. The total industry workforce, including subcontracted labour, will climb to about 400,000 people.

Demand moderates

The industry's prospects are expected to moderate in the longer term as investment into single-unit housing falls 5.2% to settle at $31.8 billion in 2016-17. This turning point corresponds with the typical four- to five-year cycle in housing demand. It also partly reflects the expected tightening of investment finances following several years of strong economic expansion, and the stock of existing homes approaching the underlying requirement. The upward pressure on mortgage interest rates is expected to gather momentum in the mid-term, as government looks to fund the recent deficit increases (increasing the demand for cash), which will push up bond rates on international markets.

Industry revenue is forecast to contract by 4.0% to $36 billion in 2016-17, as the level of new single-unit housing starts falls by over 5,000 to 110,000 dwelling units. The industry will continue to derive solid demand from the home improvements market and the aligned multi-unit apartment market.

Key success factors

• Development of a symbiotic relationship with another industry: Close linkages with financial institutions enable adequate funding of activity.
• Membership of an industry organisation: To be eligible for insurance, operators must have membership with the Housing Industry Association or the Master Builders Association.
• Access to highly skilled workforce: It is essential that industry participants have access to a pool of skilled subcontractors or skilled employees, as this industry is prone to cyclical shortfalls in skilled labour.
• Having contacts within key markets: Businesses must have significant promotion of different types of houses at various display centres.
• Ability to expand and curtail operations rapidly in line with market demand: The ability to read the building cycles and to position operations according to likely outcomes is important.
• Access to the necessary amount of land and type of property: The larger-scale players in this market typically develop and promote residential subdivisions, and thereby profit from both construction and property development activities.

This article originally appeared on SmartCompany.

Photograph by Tim Gould