This is what Australia's residential building slowdown could look like

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Australia witnessed an unprecedented residential building boom in the 2015/16 financial year, beginning construction on more homes than ever before.

But now the boom is past its peak. Building approvals are trending lower, led by a sharp decline in those for apartments.

The question many are now pondering, including policymakers in Canberra and Martin Place in Sydney, is just how fast, and steep, the decline in residential construction will be.

There’s no shortage of uncertainties as to what the future holds.

Mortgage rates are increasing and the screws are being tightened on property investors, leading to a decline in housing finance. And demand from foreign investors, a large proportion from China, is also being questioned given higher stamp duty charges on foreign buyers in some of Australia’s largest housing markets, along with ongoing capital restrictions on Chinese investors moving their money out of the country.

On top of the decline in building approvals, it’s something that many are watching closely given the importance of the building industry on economic activity, employment growth and housing affordability.

Like many others, Australia’s Housing Industry Association (HIA) is of the view that the nation’s residential building boom is past its peak, although, differing it from some of the more bearish forecasters, it says the slowdown is likely to be modest in the years ahead, except when it comes to apartment construction.

“Having touched record levels during 2016, the latest report predicts that new home building starts are set to move lower over the remainder of 2017,” said Shane Garrett, senior economist at the HIA.

“Even though new dwelling starts will decline over the next couple of years, the annual volume of new home starts is not likely to fall below 170,000 at any stage.

“By any standard, this is still a very robust level of activity.”

According to the group’s latest forecasts, 221,500 new dwellings will begin construction in the current financial year, down 4.5% on the record-breaking figure of 231,000 seen in the 2015/16 financial year.

Looking further ahead, it forecasts dwelling starts will decline by 10.7% in the upcoming financial year before bottoming out in 2018/19 around 177,000 commencements.

Source: HIA

While a modest downturn, and one that would still leave starts at an elevated level compared to historic norms, the HIA says that most of the decline will be driven by apartment commencements which are expected to tumble from recent peaks.

“The multi-unit side of the market is expected to drive the downturn in residential building, with commencements on this side of the market projected to fall by 41% from peak to trough,” says Garrett.

He points to a “hit” to investor demand from recent regulatory changes, along with “obstacles to foreign investor participation”, as two factors that will contribute to this sharp decline.

Certainly not an unrealistic expectation, even if it’s coming from the peak body of Australia’s housing construction industry.

However, these are forecasts, and as anyone who has had to do this task in the past knows, they’re often prone to error.

The moderation in construction levels over the next couple of years may be far slower, or it may be far quicker.

If it’s the latter (emphasis on the word “if”), it will leave Australia’s economy vulnerable to an even more pronounced growth slowdown than that we’re currently seeing, and will place increased pressure on households, governments, non-mining business investment and foreign commodity demand to help bolster economic activity.

Whether they’d be able to deliver on that front is questionable should residential construction slow more than what is currently expected, particularly when it comes to households, the largest part of the Australian economy.

As JP Morgan’s Australian economics team pointed out earlier this month, the construction sector is the third-largest employer behind healthcare and retail in Australia, and if runs into trouble, it could mean trouble for the broader economy.

Source: JP Morgan

“It is not hard to see a circumstance in which the Australian consumer comes under more pressure. If the labour market eventually buckles, then the RBA may be facing a more acute collapse in employment growth and consumption,” economists at the bank wrote.

“This places greater pressure on other components of domestic demand, such as government infrastructure and private capex, to deliver robust outcomes.”

JP Morgan says that given the details of Australia’s March quarter GDP report released earlier this month, “such outcomes cannot be taken for granted”.

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