Australia’s Housing Crisis: Why ‘Build More Houses’ is not as Straightforward as it Sounds
18 October, 2024
Introduction
Australia’s infamous housing crisis has been at the forefront of political and economic debate for the past few years, and for good reason: what seems to be a perpetual increase in house prices has resulted in decreasing home ownership levels and widespread rental unaffordability across the country. From around 2014 to date, house prices have increased by an astounding 75%. Further, relative to 1999-2000 statistics, home ownership has fallen by 4%, with the proportion of the population renting increasing to 31% (Grudnoff and Jericho, 2024). This is in conjunction with rental affordability being at the lowest point in 17 years, according to a recent report published by PropTrack: in fact, households who are earning the median income of approximately $110,000 annually can only afford to rent a mere 39% of the properties listed on the market (Lang, 2024). Further, 2024 data from the ABS indicates that capital city rents have increased by as much as 15% since 2019 (pre-COVID) (Australian Bureau of Statistics, 2024).
The political economy of Australia’s housing crisis is an exceptionally complex and nuanced area of study, with many scholars disagreeing about the causes of the affordability problem, and therefore the solutions. A deep-dive into this discussion goes well beyond the scope of this article, however it is important to note that while most economists generally agree with the idea that increasing housing supply should put downward pressure on prices and rents (given that more homes are built in areas where demand is high, lowering prices across the board), many also highlight that this is not the only solution. In fact, focusing on reforming the existing tax concessions for private investors (negative gearing and capital gains discounts) could be more viable (Pawson, 2018). However, in light of the federal and state governments recently agreeing to a National Housing Accord – which endeavours to build 1.2 million new homes over the next 5 years in order to expand the national housing stock (supply) by around 10% – the focus of this article will be to examine whether or not Australia’s building industry is actually equipped to meet this ambitious supply-side policy, which in theory, should see an improvement in housing affordability.
1.2 Million New Homes Over the Next 5 Years: Pipe-Dream or Viable Solution?
While there are many potential root causes of Australia’s housing affordability crisis – ineffective housing policy, a culture of property speculation (the flipping of real estate for the sole purpose of accumulating capital gains/profits), demand for real estate ‘hot-spots’ being greatly inflated due to wealth accumulation behaviours, etc – an overarching reality is clear: demand for housing (particularly within inner-city and coastal areas) is significantly outpacing supply (Pawson, 2018). With the release of the National Housing Accord, soaring house prices and seemingly vigorous demand, it would appear that the home-building construction industry is in a prime position to increase their margins and experience a ‘boom’. Yet, recent reports and research notes indicate a starkly different reality. In fact, profitability in the house building industry has sharply declined, housing completion numbers have notably fallen, and over the past two years, the number of ‘construction insolvencies’ has almost tripled (Wilson, 2024). With the demand for houses in Australia at an all-time peak, how is it possible that the home building industry is suffering? A recent research report conducted by The Australian Industry Group sought to answer this question, and provides some valuable insights which will be outlined below. Ultimately, the health of the residential building sub-industry is crucial to addressing the housing affordability crisis in Australia, and unless some significant changes are implemented, the aspiration to build 1.2 million houses in 5 years will continue to remain far out of reach.
Australia’s Construction Sector: A Story of Intra-Industry Divergence
In terms of the aggregate statistics, Australia’s construction industry is growing in size, having completed approximately $260 billion worth of work in 2023, which in real terms is the highest annual amount reported in history, representing an 8.3% increase in industry size relative to the previous year (Wilson, 2024). Although, this growth can mainly be attributed to ‘engineering construction’ work, referring to the building of large-scale energy, transport and other industrial projects. This type of work has soared since the pandemic, currently accounting for more than half of all construction activity across Australia, facilitated mainly by the federal and state governments’ fiscal policy initiatives (large amounts of government spending on public works). On the other hand, even in the face of a property market boom and skyrocketing house prices, residential home building only accounted for $81 billion of the work completed in 2023, with home building rates failing to recover from the 10% drop seen in 2020 (the midst of the pandemic) (Wilson, 2024). The main explanation for this phenomenon is a notable divergence in commercial viability across the two main sub-industries that constitute construction services: building and civil engineering. What is the cause of this divide? Differing profit margins, inefficient risk/cost allocation, distinct contracting techniques and delays in planning/approvals. Let’s investigate further.
Data from 2022-23 indicates that profit margins have gone in opposite directions for the two sub-industries: margins in building construction have plummeted from pre-pandemic levels of approximately 8% to a much lower 5.6%, while conversely, civil engineering margins have jumped from 4.2% to 5.5% (Wilson, 2024). Generally speaking, engineering projects, which are often government-owned or publicly run, present a much lower degree of risk compared to private-sector building works. As a result, traditionally, builders are compensated for incurring higher risk in the form of larger operating margins, but this premium has more or less disappeared across Australia’s construction industry in the aftermath of the pandemic. There are various reasons for this, but it can mainly be attributed to consistent project overruns, exacerbated by global supply-chain disruptions, uncertain geopolitical conditions, decreased investment, etc. Ultimately though, the diverging margins are a result of the respective sub-industry’s capacity to pass on rising costs to their consumers. Since 2017-18, the building sub-industry has seen material costs increase by 29% and wage input costs rise by 42%, while the civil engineering sub-industry has faced a rise in material costs of 64% with wage costs up 31%. Yet despite this, sales income in civil engineering has increased by 48% (which sits approximately in the middle of the rise in material and wage costs), whereas income for building construction has grown only 22% (falling below the increases in both material and wage costs) (Wilson, 2024). This clearly indicates that the building sub-industry is failing to earn enough money from their clients to account for the soaring costs, while the civil engineering sector is successfully passing on a large proportion of the increased input costs onto project owners. This is affirmed by the 17% drop in gross operating profits (before tax) in the building sub-industry since 2017-18, while civil engineering has seen an astounding 140% increase (Wilson, 2024). In a full-circle moment, this can largely be explained by the different contracting techniques commonly used across each sub-industry:
Building projects, which are often smaller in scale and privately owned/operated, continue to feature fixed-price, fixed-time (‘traditional’) contracts. As explained in a previous HJA article, these types of contracts confer a disproportionate amount of risk onto the Contractor (builder), as any cost blowouts/time delays caused by supply-chain disruptions or inflationary pressures for example must be addressed solely by the builder. As such, the rising costs seen across the entire construction industry post-pandemic are being unfairly incurred by building firms, resulting in a massive drop in profits and by extension, smaller margins
Alternatively, large-scale engineering projects – where there is a growing trend in Australia of public ownership and delivery, along with a huge influx of work due to continued fiscal policy from the government – are frequently adopting a more collaborative contracting approach. This is characterised by a much more equitable delegation of contractual risk between the Contractor and consumer (often a Government Owner), and thereby disperses a large portion of common cost increases (or delay obligations) across multiple parties, increasing profits for engineering businesses and minimising the risk of insolvencies and incomplete projects.
So, given net returns are more-or-less equal across the sub-industries (profit margins are very similar), and considering civil engineering works offer a substantially lower amount of commercial risk (financially and reputationally), the economic incentive to engage in home building is almost non-existent, empirically reflected by the persistent drop in home building rates across the country since 2020.
What can be done?
As it currently stands, it would appear that Australia’s residential building industry is simply not equipped, in terms of economic incentives and commercial viability, to deliver on the ambitious goal of building 1.2 million new homes across the next 5 years, as promised by the government. Within the National Housing Accord, the federal and state governments have only officially committed to being directly involved in the building of 20,000 affordable houses, with the remaining 98.2% to be delivered solely by the private sector (Wilson 2024). As outlined throughout this article, this is much closer to a far-fetched pipe-dream than an achievable reality: it would require the building of an average of 60,000 new dwellings each quarter, and with the 2023 quarterly average being a measly 43,200 (even less than 2020, a year characterised by lockdowns and business stoppages), the chance of meeting this target seems exceptionally slim (Wilson, 2024). Therefore, if Australia wishes to ameliorate the housing affordability crisis, and meet its new housing needs, the home building sector needs immediate support. While the construction industry as a whole is healthy, and even growing at high rates, this is simply a reflection of large public spending on infrastructure projects boosting up the civil engineering sub-sector, while the home building sub-industry has been left in the dust. HJA proposes the following potential solutions, to be considered by the federal and state governments, lobby groups and private-sector building firms alike:
The home building sector should be subsidised, through indirect financial support arising from the federal and state governments agreeing to take up a notable portion of the building contracts for the 1.2 million proposed new houses (far more than the currently agreed 20,000). That is, fiscal spending policies should be re-evaluated so that government revenue is directly flowing into the home building industry, with less of a focus on civil engineering.
Collaborative contracting approaches ought to be implemented so as to increase margins for home builders and reduce the large degree of commercial risk posed by the traditional fixed-price contracts that are frequently used in private-sector dealings.
Further, so as to improve productivity and efficiency, the government could look into bundling specific geographical target areas into large-scale home building projects to be put out to tender, making collaborative contracting structures more applicable (as they can lead to unnecessary complications and unclear contractual obligations when used for smaller-scale projects with quick turnover times, such as singular home builds). This would hopefully incentivise much quicker planning approval processes as well, further improving efficiency.
Private-sector building companies and unions should lobby relevant government bodies to help lower input costs across the sub-industry. This could be in the form of tariff reductions for crucial materials or the establishment of bulk-trade agreements with cheap foreign suppliers. As with most economic policies, there is a trade-off: while domestic construction material suppliers may suffer due to being less competitive, commercial viability for Australian builders will be significantly improved due to cheaper prices, increasing operating profits and ideally leading to higher margins.
Conclusion/Executive Summary
In summary, while increasing the supply of homes could be a viable solution to improving the housing affordability crisis plaguing Australia, the current state of the home building construction sub-industry is concerning to say the least. Input costs are up, profit margins are down and the inability to share risk has forced home builders out of the market or encouraged them to seek out more commercially feasible alternatives, especially in the form of more economically attractive civil engineering projects. The result is low home building rates, which certainly isn’t conducive to increasing supply. If the National Housing Accord is to be met, and the housing shortage addressed, then fiscal and trade policies ought to be re-structured to drastically improve business conditions for home builders. Only then can Australia move towards lowering house prices and improving rental affordability. As it turns out, improving the residential building industry’s economic environment might just be the key to resolving Australia’s ever-worsening housing crisis.
References
Australia Bureau of Statistics (2024). Private rent inflation: capital cities vs regions | Australian Bureau of Statistics. [online] www.abs.gov.au. Available at: https://www.abs.gov.au/articles/private-rent-inflation-capital-cities-vs-regions [Accessed 14 Oct. 2024].
Grudnoff, M. and Jericho, G. (2024). Financial Regulatory Framework and Home Ownership: Submission to the Senate Standing Committee on Economics. [online] The Australia Institute, pp.1–14. Available at: https://australiainstitute.org.au/wp-content/uploads/2024/10/P1741-Submission-on-home-ownership-pdf-1.pdf [Accessed 14 Oct. 2024].
Lang, S. (2024). Australia confronts its worst rental affordability crisis in 17 years. [online] SBS News. Available at: https://www.sbs.com.au/news/podcast-episode/australia-confronts-its-worst-rental-affordability-crisis-in-17-years/avmeriazf [Accessed 14 Oct. 2024].
Pawson, I. (2018). Reframing Australia’s Housing Affordability Problem: The Politics and Economics of Negative Gearing. The Journal of Australian Political Economy, [online] (81), pp.121–143. Available at: https://www.proquest.com/docview/2394538921/fulltextPDF/1B2880815105444DPQ/1?accountid=14723&sourcetype=Scholarly%20Journals [Accessed 14 Oct. 2024].
Wilson, Dr.J. (2024). Research Note: Australian home building in crisis. [online] The Australian Industry Group. Available at: https://www.aigroup.com.au/resourcecentre/research-economics/economics-intelligence/2024/research-note-australian-home-building-in-crisis/ [Accessed 14 Oct. 2024].
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