Safe as houses

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 Australian economy, as it can influence the pace of general economic growth, while also 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 (principally built by firms in ANZSIC E4112); and alterations and additions to existing dwellings (ie. home improvements).

The value of total work done on residential buildings is approximately $55.5 billion in 2010-11 and has grown by an average 3.3% per annum over the past five years, while the value of work done on new single housing construction currently totals $32.15 billion and has grown by an average 4.0% per annum over the past five years (i.e., subdued investment trend in the multi-unit apartment market). The number of single housing commencements totals approximately 120,000 units in 2010-11, after surging by 30.5% from the cyclical trough in 2008-09.

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

Industry revenue currently totals $37 billion, including value-added of $7.4 billion, or approximately 0.5% of Australia’s GDP in 2010-11. Over the past five years, industry revenue has averaged cyclical growth of 4.0% per annum and exceeded the pace of GDP growth (2.9% per annum), underpinned by the current strong upswing in investment conditions. Housing investment trends were subdued during the late 2000s by the combination of weaker general economic conditions; the deterioration in housing affordability; and the tightening of lending arrangements associated with the global financial crisis and the collapse of the US subprime mortgage market. The upswing in housing investment over the two years through 2010-11 corresponds with the cyclical recovery in the general economy, buoyant household income and employment conditions and the surge in underlying demand following strong population growth.

Industry employment currently totals approximately 100,000 persons, although direct employment is relatively low given the labour-intensive nature of construction due to the industry’s heavy reliance on a subcontracted labour force. The bulk of the industry’s workforce is comprised of subcontracted labour, which currently numbers about 320,000 to 350,000 full-time equivalent persons. Wage costs currently absorb about 7.5% of industry revenue, while subcontractor payments and payments to employment agencies absorb about one-quarter of industry revenue.

The industry currently comprises approximately 35,000 establishments and is characterised by its many small-to-medium sized contractors, which operate in relatively narrow regional markets. The four largest contractors generate about 10% of annual industry revenue and construct about 10% of annual commencements. Australia’s leading home builders include: BGC (Australia); Mirvac Group; Investa Property Group; Dale Alcock Homes; A.V. Jennings Limited; Henley Arch; and Devine Limited, each accounting for about 1.0% to 2.5% of the industry annual revenue and housing commencements.

The industry is forecast to experience subdued cyclical growth in revenue averaging just 1.5% per annum over the five years through 2015-16, but will remain at near-record levels of activity.

Industry outlook

Pent-up demand for new housing stemming from the recent surge in Australia’s population, coupled with the solid general economic performance, will underpin record levels of housing construction activity in the short term, however, the industry is likely to experience a minor cyclical correction in demand conditions during the middle years as housing affordability deteriorates and some of the current demand is satisfied.

Divergent trends coming to play on the housing market over the outlook period. 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 have tightened in the aftermath of the subprime market fallout in the USA and the global financial crisis. On the other hand, Australia has weathered the global economic storm better than most countries, households continue to have a capacity to take on debt, and there has been an unprecedented surge of population which puts upward pressure on housing demand. IBISWorld forecasts subdued cyclical growth in new housing construction over the next five years although the country will maintain near-record levels of housing commencements and housing investment.

The widely cyclical pattern of expansion projected for the housing market will result in revenue averaging growth of 1.5% per annum over the five years through 2015-16, matching the investment trend in the single-unit housing market but lagging well behind the projected pace of Australia’s GDP growth (3.8% per annum). Despite this marginal growth profile, the industry average annual revenue of $38.24 billion per annum over the five years through 2015-16, or 16% above the average of $32.97 billion per annum over the previous five years through 2010-11.

The value of new single housing construction will climb to a record peak in 2012-13 before contracting marginally as the market adjusts to underlying demand conditions and the high interest rate environment (investment to rebound late in the five-year period). While a cyclical pattern of investment will be evident in new housing construction, the value of alterations and additions on existing dwellings is projected to maintain strong growth of 3.5% per annum over the next five years and provide a solid platform for expansion for the many small-scale contractors servicing regional markets. Despite the strong growth in the single-unit housing market, the effect of escalating land values and material prices will see housing demand swing towards the construction of multi-unit apartments and townhouses, particularly for first-home buyers and empty nesters.

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. Much of the impetus for housing growth through the next five years will swing toward the multi-unit apartment market as first-home buyers look to avoid the escalating land values and seek lifestyle inner urban locations. Investment by first-home buyers in the single unit housing will be concentrated in new housing subdivisions in the outer fringes of the metropolitan areas, as each of the state governments have moved to open up land for residential development.

Profits to bounce around

The industry’s profit performance is forecast to continue to strengthen in the short-term with the coming cyclical peak in housing investment, but contract in a cyclical pattern towards the middle of the five-year period as demand conditions ease. Generally the operating profit share of revenue should remain consistent with the long term average, ranging between 12% to 13% over the course of the next five years and industry gross operating surplus (i.e. operating profit) is forecast to average growth by 2.0% per annum over the five years through 2015-16, matching that of revenue and value added. The profit performance is likely to be strongest for the larger scale builders who combine construction with land development activities (particularly lifestyle community developments).

Industry wage costs are also projected to average growth of 1.5% per annum over the next five years, driven by marginal growth in direct employment (0.5% per annum), and higher real wage rates as demand conditions tighten in the skilled labour market (particularly in Western Australia and Queensland).

Sluggish short-term growth

The industry is forecast to display a sluggish growth performance early in the five-year period with the continued strong underlying demand for housing is not eventuating into increased construction due to the deterioration in housing affordability and particularly the recent escalation in mortgage interest rates following the moves by the RBA to tighten monetary policy settings. The short-term prospects are for construction to stall in response to the increases in official interest rates in March, April, May and November 2010 which coincided with the absence of the additional first-home buyers subsidies. However, the underlying demand remains very high and this along with the stronger general economic growth, including the buoyant labour market, will support investment early in the five-year period.

The value of new single-unit housing construction will climb marginally by 1.1% in 2011-12 and strengthen by 5.4% to reach a record cyclical peak at $34.25 billion in 2012-13 with the number of single-unit commencements rising by 3.8% to total 124,500 units. This upswing of investment coupled with the recovery of demand conditions in the multi-unit apartment market, will see industry revenue initially stall in 2011-12 before climbing by 7.0% to a record $39.6 billion in 2012-13, lifting direct employment by 4,000 people to total 104,000 people in 35,500 establishments.

Housing demand peaks and turns down

The industry’s prospects are expected to moderate towards the middle of the five-year period as investment into single-unit housing falls by 6.0% from the 2012-13 cyclical peak to settle at $32.20 billion in 2014-15. This turning point corresponds with the typical four-to-five year cycle in housing demand and 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 towards the middle of the period as government look to fund the current deficits increases (increasing the demand for cash), which will push up bond rates on international markets.

Industry revenue is forecast to contract by 5.1% in 2013-14 and by a further 1.1% to $37.20 billion in 2014-15, as the levels of new single-unit housing commencements fall by 9,500 units from the record cyclical peak in 2012-13 (down 7.7%). The industry will continue to derive solid demand in the home improvements market and the aligned multi-unit apartment market. Industry employment will contract by about 5,000 over the two years to total 99,000 people in 35,000 establishments by the 2014-15 cyclical trough (remaining substantially above historic employment levels).

Next cyclical upswing in housing

Continued strong population growth through natural increase and immigration, will lift underlying demand for total housing construction to about 170,000 to 175,000 units per annum over the five years through 2015-16, with approximately 65% of this supply being in the single-unit housing market. This high demand for new housing for purchase or rent, coupled with the stabilisation of interest rates and the continued solid economic indicators, paves the way for a cyclical upswing of investment late in the five-year period.

The value of new single-unit housing construction will climb by about 7.5% to $34.6 billion in 2015-16, lifting new commencements by 6.1% to 122,000 units, roughly comparable with the current level. This upswing is forecast to drive industry revenue up by 7.5% to a record peak at $39.8 billion in 2015-16, to be approximately 8.0% above its current level and 28% above that of the 2008-09 cyclical trough. Industry employment will climb by 3.5% to 102,500 people late in the period and the total industry workforce including subcontracted labour will climb to about 400,000 people by 2015-16.

Industry performance

Key external drivers

Housing affordability: The level of housing affordability is the key determinant for new housing demand over the short-to-medium term. During the past five years housing affordability improved to its most attractive level on record, with mortgage interest rates falling to historically low levels and a strong pace of employment and income growth. Attractive housing affordability supported strong demand for housing and more closely equated short term housing demand to that of long term underlying demand.

Dwelling approvals: Trends in dwelling approvals provide a forward indicator of demand for new housing construction and hence growth in industry revenue.
Housing Loan Rates – Residential

The prevailing and expected mortgage interest rate settings (cost of financing housing construction) have a fundamental impact on the short to medium term pattern of demand for construction. The exposure of households to debt has risen at an accelerated pace over the past five years. This exposes mortgage borrowers to substantial increases in repayments resulting from upward movements in interest rates.

Population: Trends in Australia’s population size and growth directly underpin the long term demand for housing construction. Demographic factors indicate the required minimum stock of housing but not the value. Net overseas immigration accounts for approximately half of Australia’s population growth and incoming migration immediately generates increased demand for housing construction (rental and home purchase).

Household formation: The age distribution of the population and the resultant household formation patterns influence the long term demand for new housing construction. Strong immigration (typically of household formation age) and falling fertility rates have contributed to the aging of the population.

Key success factors

IBISWorld identifies 250 key success factors for a business. The most important for this industry are:

Development of a symbiotic relationship with another industry: Close linkages with financial institutions to enable adequate funding of activity.

Membership of an industry organisation: In order to be eligible for insurance operators must have membership with the Housing Industry Association (HIA) or the Master Builders Association (MBA).

Access to highly skilled workforce: It is essential that industry participants have access to a pool of skilled subcontractors and/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 position operations according to the likely outcomes.

Access to the necessary amount of land/type of property: The larger scale players in this market typically develop and promote residential subdivisions and thereby profit from both the construction and property development activities.

Barriers to entry

Barriers to entry in this industry are medium and are increasing.

The barriers to the entry of new competitors have tightened considerably in recent years in response to state-based legislation governing owner-builders and the problems obtaining adequate warranty insurance coverage. Qualified tradespeople with the appropriate state-based registration have relatively easy access to the industry, but their capacity to compete for a share of the total market may be severely limited by the highly competitive conditions imposed by existing players, their lack of proven experience and the insurance constraints.

State and territory governments require builders to register with recognised industry associations (such as the Housing Industry Association or the Master Builders Association) in order to verify competency and qualify for insurance coverage on construction projects. New entrants not holding industry association accreditation will find it increasingly difficult to obtain warranty insurance and hence compete for contracts in this market.

The national introduction of Registered Building Practitioner (NBP) certificates program has gained momentum since the early 2000s. Ensuring competency levels help safeguard the general industry and particularly building indemnity insurers. Failure to obtain registration could restrict newcomers to very small alteration and repair work at the bottom end of the market.

The existing firms are advantaged relative to new entrants in several ways; access to a pool of skilled subcontractors; ongoing arrangements with material suppliers; ongoing arrangements with financial institutions and property developers; and, ability to display completed examples of workmanship in a local market and leverage off word-of-mouth.

New entrants face intense competition from the larger scale building firms that compete for market share using marketing techniques ranging from: mass market advertising; joint venture development promotions with government and industry bodies; financial packages arranged with financial institutions (or in-house) and real estate agents; and inducements such as free appliances.

The global insurance crisis affects the capacity of residential builders to obtain building warranty and professional indemnity insurance. This acts as an additional barrier to the entry of small scale firms into the industry. Existing builders are encountering difficulties obtaining adequate insurance coverage and are confronted by steep rises in premium costs and limitations in the coverage available. New entrants, without a proven track record, may be disadvantaged when obtaining insurance coverage (i.e. higher premiums, severe coverage limitations, or even refusal of cover).

Robert Bryant is the general manager of business information firm IBISWorld.