WESTPAC: A 'nasty air pocket' could be waiting for Australia's construction boom

Australia 108 in Melbourne is set to become the tallest residential building in the Southern Hemisphere.

Australian building approvals are booming. In the 6 months to February they’ve risen 12% in trend terms, a gain that has seen the annual pace jump to just under 225,000, an all-time record high.

While years of under-building, looser monetary policy settings from the RBA, and foreign investment in new housing stock have been cited as reasons behind the increase, the question now is how long can the renaissance in residential construction can last.

Is it here to stay or is there a risk that we may be left with an oversupply of residential housing, particularly for units?

In a research note released earlier today, Westpac looked into the recent trends in building approvals. In what is remarkable – or perhaps predictable if you’ve been looking at the skylines of many Australian cities lately – they found large projects, those which contain 270 dwellings or more, were entirely behind the surge seen since August. That’s an increase of just under 15,000 in annualised terms.

They note that excluding these large projects – which are basically big apartment developments – approvals were flat to slightly down over the same time period.

So while the headline approvals figure is accelerating, it’s entirely driven by huge multi-dwelling developments, predominantly in New South Wales, Victoria and Queensland.

Interestingly, when you take out large developments, the slowdown in building approvals mirrors the responses people give to the question “whether it is a good time to buy a dwelling” within Westpac’s monthly consumer confidence survey. So on balance, the number of people in the survey who are optimistic about the housing market is falling.

Over the past decade the relationship between the survey and approvals has been strong, particularly since 2008, with demand for new housing stock largely reflective of the sentiment expressed by consumers. However, as the below chart shows, a disconnect in the relationship emerged at the beginning of 2014, with total approvals soaring while sentiment towards housing has softened.

Basically, people are have become less optimistic about the housing market, despite the strong price growth in the major cities.

Is there a risk that the surge in approvals could potentially leave Australia with a glut of high-density, large-scale housing stock? Or is it simply a reflection of new, external forces such as demand from foreign investors?

It’s not an easy question to answer, but when a previously strong relationship suddenly disconnects it’s certainly worth thinking about.

Westpac notes that there’s been a recent uptick in buyer sentiment triggered by the February rate cut from the RBA, but notes “the lagged effect of previous weakness and potential for gaps in the lumpy pipeline of ‘large projects’ means approvals could easily hit a nasty air pocket sometime in early 2015.”

Look out.

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