The downturn in Australian housing construction goes from bad to worse

Stephen Pond/Getty Images
  • Conditions across Australia’s construction sector remain bleak.
  • Activity levels are deteriorating across all parts of the sector, led by dire conditions for residential construction.
  • Employment has now fallen for six months and is speeding up. The construction sector employs over 1.1 million Australians.
  • New orders continue to decline, and at a faster pace, across all areas except for commercial construction.
  • Activity across Australia’s services sector — the largest employer in the country — fell at the sharpest pace in four years in January.
  • The RBA says the downturn in the housing market “is not expected to derail economic growth”.

After a terrible end to 2018, conditions across Australia’s construction sector remain bleak in early 2019.

Activity continued to deteriorate at a rapid pace and were broad-based. The decline was horrendous in the residential sector.

The Australian Industry Group’s (Ai Group) Performance of Construction Index (PCI) stood at 43.1 in January in seasonally adjusted terms, up 0.5 points on the level reported previously in December.

The PCI measures changes in activity levels across Australia’s construction sector from one month to the next. Anything above 50 signals that activity levels are improving while a reading below suggests they’re deteriorating. The distance away from 50 indicates how quickly activity levels are expanding or contracting.

So at 43.1 in January, the PCI indicates that activity levels continued to weaken sharply last month, albeit at a marginally slower pace.

As seen in the chart below, the recent deterioration across the sector is in stark contrast to what was seen throughout most of 2017 and the first half of 2018, mirroring so many other housing indicators of late.

Ai Group

“The slightly milder decline in January reflected less pronounced reductions in activity and new orders,” the Ai Group said.

“However, highlighting the soft overall state of business conditions heading into 2019, both employment and deliveries from suppliers contracted at steeper rates during the month.”

According to survey respondents, staffing levels were cut for a sixth consecutive month, and at a more rapid pace, an unsettling outcome on the outlook for employment given the sector employs almost 10%, or over 1.15 million, of Australian workers.

Margin pressures also remained acute with input costs soaring while selling prices went backwards.

“The wide gap between these price series demonstrates that profit margins remain tight for many businesses in the construction industry,” the Ai Group said.

“This continues to indicate that rising input prices and other costs are not, on average, being passed on to customers, reflecting the strong competition among builders in securing work.”

And that work is drying up. Fast.

New orders — seen as a lead indicator on activity levels in the future — declined at a slightly slower pace in January, although the pace was still brisk. The improvement was solely because of a less-severe decline in commercial orders, masking larger declines in new residential and engineering work.

That suggests the downturn across the sector is unlikely to ease in the near-term, especially in the residential space.

That’s a concern given how fast conditions are already deteriorating in the residential construction sector, as seen in the right-hand side of the table below.

Ai Group

Like the headline PCI, a reading below 50 indicates a decline in activity levels from a month earlier. To remove volatility created by seasonal patterns, the Ai Group presents the subindex results in trend terms.

Put bluntly, conditions for housing and apartment construction are horrible, sitting at the worst levels in years.

“Apartment building activity declined for an tenth month in January, and at a steeper rate,” the Ai Group said.

“The sector’s subindex registered 24.9 points in January, a fall of 1.6 points from the previous month and the most subdued reading since contracting at the same sharp rate in July 2012.

“The apartment sector has now experienced steady or declining activity in 15 of the past 18 months following a weakening in new orders commencing from September 2017.”

In late 2014 and early 2017 respectively, APRA, Australia’s Banking Regulator, introduced caps on investor housing credit growth and interest-only mortgages, a factor that helped to cool rampant investor activity, particularly in Sydney and Melbourne, and slow investor housing credit growth.

However, the latter move came after a boom in apartment construction was already underway, contributing to the dire condition seen across the apartment construction sector today as a record wave of completions hits at a time when demand is weak.

Uncertainty about the whether the tax treatment of housing will change following the upcoming federal election is another factor that is clearly weighing on investor demand, something that, to this point, has only been partially been offset by an improvement in first-home buyer activity.

That helps to explain why approvals to build new apartments have cratered in recent months.

While not as severe as the deterioration in the apartment sector, the Ai Group said conditions in housing construction also weakened at the sharpest pace in years.

“House building contracted for a sixth consecutive month in January,” it said.

“The sector’s activity subindex decreased by 1.9 points to 34.4 points, indicating a sharper rate of decline relative to December.

“It was also the softest reading on housing activity since September 2012 and was associated with a sixth month of contraction in new orders.”

The news for non-residential construction was also fairly dire, including for engineering activity that was enjoying boom-like conditions only a few months ago.

Its subindex slumped to 43.3, the weakest result since early 2016.

“This reflects a soft patch for new work with businesses reporting a weaker volume of new work in January following the completion of contracts towards the end of 2018,” the Ai Group said.

The commercial subindex also fell to 44.9, again the weakest level since early 2016.

The PCI rounds of a weak start to the year for the Australian economy. Activity levels at manufacturers improved marginally in January, although that was more than offset by a steep deterioration across the far larger services sector which recorded the largest decline in four years over the same period.

All up, it suggests momentum across the Australian economy has slowed in recent months, continuing the trend seen in the September quarter national accounts.

The RBA is taking notice, trimming its forecasts for GDP growth this year and next by 25 basis points to 3% and 2.75% respectively. However, at this point, the bank does not expect the downturn in the housing market will upend the Australian economy.

“At this point, what we are seeing looks to be a manageable adjustment in the housing market,” RBA Governor Philip Lowe said in a speech delivered earlier this week.

“It is not expected to derail economic growth.”

However, Lowe added the caveat that given the level of uncertainty as to what the housing downturn may do to the economy, the bank “is paying very close attention to how things evolve”.

Based on recent evidence, the answer so far this year is not all that good.

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