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The Reserve Banks of Australia (RBA) and the federal government have gone head-to-head with ambitious, yet conflicting, goals.
On the one hand, the RBA just increased the cash rate by three per cent in 2022, with a further increase in February this year, handing down the fastest increase in a generation. Higher interest rates will bring the current building boom to an end. Sales of new homes are falling; loans for new housing have retreated to pre-pandemic levels and along with other leading indicators, this shows a market slowing down.
It typically takes six to 12 months for a change in the cash rate to fully flow through to the wider economy. In this cycle, the lags are treacherously long. When the cash rate was increased for the first time in May 2022, there was a record volume of homes under construction. There was also a record volume of homes approved but not yet commenced as well as a record volume of homes sold but not approved. Sales of new homes remained strong.
This large pipeline of building work is still being completed and will continue to ensure that starts remain robust until mid-2023. This will delay the full adverse impact of the first increase in the cash rate on building activity, employment onsite and consumption of materials until 2024. This treacherously long lag raises a very real risk that the RBA goes too far, too soon, in this cycle of rate increases. The consequences of overshooting the cash rate in this cycle are a deeper slowdown in building activity in 2024 and beyond, which will slow wider economic activity, without necessarily lowering inflation to the RBA’s target range sooner.
The cash rate-induced slowdown will also be compounded by rapidly rising costs for land, labour and materials as well as the additional costs imposed on building through changes to the National Construction Code. These factors would have slowed building activity, without the intervention of the RBA.
On the other hand, the Australian Government has announced a goal to build more than one million homes over the next five years. This announcement follows from research undertaken by the National Housing Finance Investment Corporation (NFIC). It recommended in 2020 that Australia should add 1.7 million homes to the pool of housing by 2030. If we assume that the demolition of housing in the five years to 2021 was to continue throughout the decade to 2030, then this goal of 1.7 million ‘net’ new homes requires two million homes to commence construction in the decade to 2030, or one million every five years.
This is a stretch, but possible. In the five years to 2018, there were more than 1.1 million new homes built in Australia, peaking at 234,780 in 2015/16. This included a record boom in apartment building as east coast capital cities played catchup from the ‘Sydney is full’ era of underbuilding. Detached home building also remained strong off the back of rapid house price growth. This boom cycle came to an end as house price growth slowed due to the large volume of supply. It was further exacerbated by the RBA, APRA and ASIC tightening access to finance through macro-prudential restrictions.
One million homes started within five years will be sufficient to ensure that the acute shortage of housing supply does not deteriorate further, but it will not be sufficient to address the undersupply. To achieve this goal, state and local councils will need to improve the supply of land and infrastructure and lower the cost of delivery. It will also be necessary for the Australian Government to minimise additional costs imposed through building code changes and reduce the costs imposed on suppliers of building products, many of which are energy intensive.
The conflict between the RBA slowing housing activity to cool the economy, and the Australian Government seeking to increase housing supply, will be the most significant factors affecting starts over the next five years.
A return of stable and reliable migration, strong employment growth and demand for exports should ensure a return to a robust national economy that is able to withstand changes in global economic cycles. A stabilisation in housing density, a partial return to working from the office and the end of supply chain challenges will aid stability.
But as the RBA makes it harder for the federal government to achieve its goal of one million homes, it will need to offset this with more than just an increase in new expenditure on public housing. However, an increase in public housing is warranted as the shortage of housing forces more households out of the private rental markets.
The task of one million homes will also need state and local governments to commit to this task and collectively lower the barriers to the construction of new homes.
First published on 14 March 2023