A construction boom threatens to create a glut… but only in some segments.
Let’s take a look at one of the worst-case scenarios. I’m seeing this argument making the rounds more and more these days, but if we stop and hold it up to the light, does it hold water?
This is the ‘growing glut’ argument. The idea is that Australia is facing the twin shocks of a rapid build up in housing supply, at exactly the same time that population growth is slowing.
That’s going to throw the market into ‘glut’ – where there are more houses than people who want them. Rents will fall and prices will crash. And “Pal” will pivot from dog-food to aged-care nutrition.
Now we can’t write this off entirely, because some of the trends that this story is built on are true. It’s just that picture is generally more complex that the sound-bites will tell us.
And so I wanted to share some good work Paul Bloxham at HSBC has done in pulling this apart.
So the first point is yes, housing construction is ramping up and population growth is slowing.
If we look at dwelling approvals and dwelling construction, we can see that both have jumped up to the highest level in over 20 years. The leading nature of approvals says that we should see exceptionally high levels of housing supply coming on-line over the next year or so.
However, this only tells you so much, because a lot of this pick up is driven by inner-city apartments in Sydney and Melbourne. We’ll come back to that. But at the national level, yes, we’ve seen a big pick up in supply.
At the same time, population growth has falling, driven by falls in net migration (apparently kiwis packing up and going home has a lot to do with this…)
However, at a population growth rate of 1.5% a year, we’re still at the high-end of the spectrum, and one of the highest levels since the late 80s. It’s just that we had such phenomenal population growth following the GFC, that it looks a little ordinary now. It isn’t. It’s still strong.
Now we want to compare supply and demand here, to understand what’s happening to prices. But we can’t directly go from population growth to housing demand. We live in groups, and the size of those groups varies.
And household size can also vary with time. It’s been on a downward trend since the second world war.
But it can also vary in response to house prices. If prices are high, then some younger people will hold-off on striking out on their own and forming their own household.
What’s more, we only get data on household size every 5 years with the census. So it can be a little tricky. It’s not straight-forward to translate population growth into housing demand.
But HSBC have had a crack at it.
And they’ve done that by assuming different average household sizes to get a ‘range’ of household demand over the past 15 years.
And this is what they come up with:
What you can see here is that, as some people are freaking out about, housing demand has fallen below housing supply, for the first time in a while.
So that will take some heat out of the market.
But the small period of excess supply we’re experiencing now is dwarfed by the prolonged and extreme periods of under-supply between 2007 and 2010, and 2011 and the start of the year.
And so even though we’re producing houses at a decent clip now, we still have a considerable under-supply to work off.
And as long as we have an under-supply, there will be upward pressure on house prices. It might be less pressure than we had before, but it is still there. The drive is still towards higher house prices.
It’s not until we’ve worked off the total undersupply and moved into total over-supply that we start to see the market balance weighing on prices.
So when might that happen?
We’ll HSBC have tried to model this.
On their estimates, the housing undersupply peaked at a shortage of around 200,000 houses in 2012.
Since then, the shortage has been easing, to a current shortage of about 100,000 dwellings.
Going forward, assuming different household growth scenarios, it looks like we get back to a balanced market sometime around 2016-17.
However, there are a couple of assumptions here. The first is that the market was balanced in 2001 – our starting point.
Was it? Maybe, maybe not. It’s impossible to know. But it can have a substantial impact on our estimates. For example, if the market in 2001 was actually undersupplied by just 50,000, that pushes our return to balance back by a full year.
The other point, is that not all housing supply is the same.
It varies by state. For example, NSW has had a pronounced undersupply in recent years, and demand is still growing faster than supply.
However, in Victoria, supply and demand have been more balanced, and there hasn’t been such a large accumulated short-fall.
This means that we’ll have markets coming back to balance, or moving into oversupply at different times, and we’ll see very different pricing responses.
The last point I’d make is that inner-city shoebox apartments, and 4-bedroom homes in leafy suburbs are barely substitutes.
The construction data here doesn’t differentiate between the two, but in my mind they’re worlds apart.
And so I could easily see a scenario where some apartment segments become over-supplied and prices start to fall, while at the same time, detached houses in the same city remain under-supplied and continue to post solid price increases.
So it’s a nuanced picture. Despite what some of the alarm-farmers want you to believe, “Australia” does not have a “glut” and prices are not about to drop off a cliff.
But let them tell that story if they want to. The more buying opportunities there’ll be for buyers like me who know the devil is in the detail.
Will the construction boom cause a property crash or a soft landing?
Are prices too high in Melbourne and Sydney to invest in right now?
Kathy says
Interesting discussion. Unfortunately it doesn’t take into account demographics, in that the Baby Boomers have been starting to retire since 2011.
They will become net savers rather than net spenders and will be downsizing and selling assets (real estate, stocks and businesses) to fund their retirement years.
The following generations (X, Y, Z or millennials, whatever you want to call them) have been smaller than the boomers. Even if the population is still growing, albeit slower than usual (because our economy is essentially in a recession, even if technically it isn’t yet), there is still unlikely to be sufficient buyers of boomer assets when their retirement phase gets into full swing.
This is one of many and varied reasons China is slowing too. As well as using debt and stimulus to build huge ghost cities, they also used debt to ramp up factors of productions (factories and manufacturing plants) at precisely the same time as consumption is slowing. With the average Chinese wage still at US$6,000, they don’t have a large enough domestic market yet.
China slowing, incidentally, is also the reason that Australia ‘s economy is slowing massively unless they can quickly develop a non mining replacement, and no, housing construction isn’t it, which is hardly a productive use of our resources. Once a dwelling is built it doesn’t provide any further useful productive purpose or ongoing employment except for maybe a property manager or the occasional plumber or electrician or painter.
At the moment property relies on the greater fool theory, in that hopefully a greater fool will come along and pay me more for my property than I paid for it. Once that stops, so does capital growth, which also incidentally, is reverting back or trying to revert back to the mean of only growing at inflation rates, which property should do in a properly functioning economy (which admittedly it isn’t globally and hasn’t been for the past 50 or so years due to the availability of cheap credit).
Another incidental bit of trivia, asset price deflation was a perfectly normal event in economies until the advent of central banks which tried to stop natural price deflation. Look to Japan to see how that’s turning out, as they enter their third lost “decade” of deflating asset prices that have never returned the highs of the 1990’s. Their Baby Boom period started 20 years before Australia’s, the US and Europe. We can see our future by looking at what happened (and continues to happen) there, not that anyone’s taking a blind bit of notice.
Anyway, the point I’m making is that as more and more Boomers retire and move to retirement villages or aged care facilities, they will sell their assets, including their PPRs, investment properties, stocks and bonds and their businesses to convert into cash so they can afford to live and pay their accommodation bonds and living expenses. In the long term, this is where the housing (and other assets) glut will come from. In the short term, the inner city and middle ring construction of endless, dreary blocks of flats in at least Sydney, Melbourne, Perth (particularly commercial stock) and Brisbane is where the current glut is.
Give it 18 months to two years and when too many investors get sick of getting too low a yield (in some cases, below inflation) while continually having to put their hands in their pockets to fund their so called “asset”, a whole bunch of them will go on the market. Then there will be a glut of no longer new flats on the market.
Joe P says
Well said ….i agree with the majority of your essay.Timing in the market is everything
However Australia can still drop interest rates further allowing investors a decent yield assuming they dont overpay for the houses.
Cheap credit fuels spending…. at least until GFC 2 hits us in the next 1-2 years…. then God help us
Watch USA implode first
ron says
golly jon you must have the universal chrystal ball. can you tell me how it is that there is always a ‘shortage’ of housing…when i see, in perth, many, many vacant homes and flats etc. in my area alone i can count 6 vacant homes..in the price range around $1-1.5m..and thats high for perth..attadale you know lol i like kathy’s contribution..namely that housebuiding is not productive ..nor is house swapping.
it seems that h.s. is our major industry at the moment. with housebuilding…we need some sort of machinery to do the earthworks for the c. pad. then you need machinery to dig the dirt to make bricks and cement. thats ok i guess…but in good ol usa the worlds biggest maker of machinery :is laying off 1000’s of workers for the first time in their history. why? cos nobody is buying their product. why? ..there is not much work overseas or demand. pretty drastic stuff..and another big maker is also doing the same thing…what is that telling us? now back to our housing…when the shell is finished we need to fit it out..and where do the fitouts come from? overseas…so we import many many lots of fitout stuff which costs more and more and creates a lessening in our balance of payments..so we are in debt. boy are we in debt. we have private debt, government debt and household debt. i can’t see any credit anywhere in australia..its all BORROWING. a deep and ever increasing black hole..and it is worldwide..over US$200trillion of it..and then there is the derivatives debt.over US$800 tn and counting. i think maybe our leaders have lost control somewhere. they fiddle with things they should stay out of. certainly the jews at the fed have lost the plot completely. they can’t even get ms yellan to make a decent coherent statement..she keeps bleating about inanities which a schoolboy would be ashamed of. and she is the mouthpiece for the ‘bank’ that virtually controls every economic move in the world. b. marvellous. glut of building?…pigs arse! sorry jon..remember john elliot? that was his favourite comment. lol the world is full of charlatans..and nowadays they are to be found in high places.: banks, politics, corporate and military..and hang the general population. we are gonna find out very soon how it will pan out. the normalcy bias will be shattered here in oz…amid cries of ‘why weren’t we told?..oh dear we have got a problem.