The new report released by BIS Oxford Economics forecasts a tough period for the Australian building industry, especially in building commencements.

However, the sector is expected to recover strongly by 2020/21.

While the 2019/20 low in commencements will still be higher than any previous cycle trough, downside risks including build quality, insurance concerns and weak presale volumes could spark a deeper correction, says the report.

In their Building in Australia 2019-2034 report, BIS Oxford Economics indicates that the real value of national building commencements contracted an estimated 12 percent in 2018/19 to A$109.8 billion (in constant 2016/17 prices), from the record peak reached the previous year. An additional eight per cent decline is forecast for 2019/20, with the fall in residential building outweighing the growth expected in the non-residential sector.

Property demand has been impacted by tougher lending practices as well as falling property prices.

“FY2019/20 should represent the trough for total building, with a strong rebound anticipated from 2020/21 onwards as interest rate cuts, easing mortgage serviceability tests and first home buyer stimulus help facilitate a broad recovery,” says Robert Mellor, managing director at BIS Oxford Economics. “Total building activity is anticipated to climb near its previous peak over the coming five years.

“Strong population growth, a rising national dwelling stock deficiency and housing stimulus are set to provide considerable support to the residential building and renovation sectors, while non-residential building is projected to remain elevated at a high base over the medium term.”

Upturn in sight for the residential sector

A residential downturn is well underway, with the number of total dwelling commencements contracting in 2018/19 by an estimated 16 percent to 191,800. Attached dwellings are estimated to have declined 24 percent, while houses declined a more modest nine per cent. Victoria (-23 percent) saw the largest decline following a record peak in the previous year, as the correction underway in New South Wales picked up pace, falling 14 percent.

However, Tasmania (+17 percent) and the ACT (+22 percent) have offset some of the falls elsewhere in total dwelling commencements.

The national rate of property turnover has dropped back considerably over the past two years, in line with falling house prices. Tighter lending conditions triggered by the Banking Royal Commission battered buyer confidence and restricted access to finance.

Land sale volumes in most key greenfield markets have fallen back sharply over the first half of 2019 and off-the-plan apartment sales have also been running at a very low level. This has baked in the current downturn, given the lag time to construction.

A suite of stimulus measures is expected to positively flow through to new dwelling construction in mid-2020 by facilitating credit availability, reducing barriers to entry and boosting confidence, thereby propelling the next upswing. These measures include lower housing interest rates with a further rate cut expected in December quarter 2019, the removal of the seven per cent mortgage serviceability floor by Australian Prudential Regulation Authority (APRA), and the Federal Government’s First Home Buyer Deposit Scheme.

Despite the severity of the downturn (33 percent decline from peak to trough), national residential commencements will trough at 152,900 dwellings – a historically elevated level.

“From somewhat of a balanced position, Australia’s dwelling stock deficiency will grow once again as rising undersupplies in Victoria, Queensland and Tasmania develop by 2020/21,” says Mellor. “We anticipate this pressure to facilitate growth in house prices and rents, helping create a renewed upswing in residential building starts through the early to mid-2020s.”

Over the four years to 2023/24, given this pressure in the market, dwelling commencements are forecast to rise a cumulative 55 percent to a peak of 236,650 in 2023/24.

Non-residential building commencements set to remain elevated

After a small step back in 2018/19, the value of non-residential building commencements will hold at a record base of around $47 billion per annum through to 2022/23, with both private and public sector demand contributing to the positive outlook.

New South Wales and Queensland will lift to record levels in non-residential building over the next two years. Continued tightness in the Sydney office market should enable this sector to continue running at a high level, while a significant pipeline of major projects across defence, health and hospitality will support the Sunshine State. Mellor has a favourable outlook for the non-residential segment, which he attributes to a combination of factors including strong population growth, tightness in some asset classes and most importantly, a strong project pipeline.

National office and accommodation buildings are expected to remain at a heightened level over 2019/20 and 2020/21, before tapering back gradually over the subsequent years. The transport, entertainment and recreation, and health building sectors are set for strong growth in the coming years.

Non-residential building activity is expected to remain near this high base until 2022/23, thanks to relatively stable economic conditions, continued solid population growth and a series of large-scale transport infrastructure projects across the nation. It will also be supported by defence projects such as the Australia-Singapore Military Training Initiative and a series of major hospital developments including the $1 billion New Footscray Hospital.

Implications: Total building commencements to fall further before growth re-emerges in all sectors by mid-2020

Notwithstanding the increase in non-residential building activity over the next 12 months, the continued contraction in dwelling commencements will drive the total value of building starts down a cumulative eight percent.

“Halfway through the residential downturn, our sights are now set on the recovery. The next pick up in new dwelling construction is expected to coincide with a continued buoyant level of non-residential investment and a turn in mining investment,” says Mellor.

“Queensland and Western Australia are well positioned to lead the next residential upturn, ahead of New South Wales and Victoria.”

The recovery in residential commencements will be led by first home buyers and upgraders. Rising pressure on the dwelling stock will tighten rental vacancy rates, and accelerate rental growth. Once gross yields for residential property appear more favourable, investor demand is expected to increase for both new and existing dwellings, but only until the second half of 2021.

Failure of investors to return to the market as expected will, however, impact the momentum needed to sustain the recovery.

“We could experience a deeper downturn before then, and a delayed recovery, if fundamental drivers of residential activity were to ease more than expected,” says Mellor.

“A crisis of confidence surrounding build quality in the apartment market has the potential to weigh further on apartment construction over the short term, adding downside risk to the outlook.”