Why housing won't help the economy's rebalancing act

Building approvals continue to decline but residential investment should provide some support to the broader economy over the next few years. Nevertheless, residential investment remains only a small share of real GDP and cannot be expected to the do the heavy lifting as our economy rebalances.

Building approvals fell by 5.0 per cent in June, missing market expectations, to be 16.0 per cent higher over the year. This partially offset by strong growth last month and reflects a continuation of the downward trend over the past six months.

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Approvals for housing, which have historically been less volatile, have peaked and have declined modestly over the past three months on a trend basis. Approvals for apartments spiked in May but have otherwise been on a sharp downward trend during 2014.

Approvals for apartments also provide a good indicator of investor activity (on those rare occasions that investors purchase new rather than existing properties), so there are growing signs that investor optimism is subsiding. It is a trend worth keeping an eye on and one that might prove important to the broader housing market over the remainder of the year.

From a construction standpoint, apartment projects typically take longer to complete and should support residential investment and the Australian economy over the next couple of years. The main concern though is that these projects are typically far riskier and more likely to be postponed or cancelled if economic conditions slow.

At the state level, data can be particularly volatile in the higher density segment. Single large projects can shift the data around significantly from month-to-month, but approvals continue to decline in each of the mainland states.

The upswing in residential investment should be concentrated in New South Wales, while both Victoria and Western Australia should expect a solid boost to construction. But residential projects in Western Australia might be the most at risk, particularly if the mining sector falls away faster than expected.

Taken at face value, and supported by strong population growth, housing investment will improve significantly over the next couple of years but those expecting construction to drive the Australian economy should probably temper their expectations.

The 2010-11 ‘boom’, during which approvals tracked awfully similar to current trends, saw residential investment rise only modestly as a share of GDP. This episode should last longer, mostly due to the high number of apartments, but it is unlikely to be a big driver of growth over the next couple of years.

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The unfortunate reality is that housing construction is hopelessly outgunned as we try to rebalance our economy away from mining investment.

Mining investment is set to fall sharply over the next couple of years and could punch a hole in the economy worth around 4 to 5 per cent of real GDP. That may, in fact, prove to be an optimistic estimate. It has become increasingly obvious that mining firms over-invested during the boom, with new production flooding the market, reducing prices and cutting margins.

Most of the heavy lifting will be done by household spending and exports; residential investment will be nothing more than a supporting player.

Unfortunately household spending has slowed significantly throughout 2014 and continues to suffer from declining real wages and a subdued labour market. The outlook for exports is much brighter but will be weighed down by lower commodity prices and is almost completely reliant on the continued success of the Chinese economy.

Low interest rates continue to support the housing sector and construction has picked up as expected. But the Australian economy needs more than just a vibrant housing sector for growth to return towards trend. The household sector needs further relief and the export sector would benefit greatly from a lower dollar. In my view that necessitates an interest rate cut sooner rather than later.