What's ahead for the construction sector?

Friday, 16 October 2009

This week we ponder interest rate rises, the rising dollar and what’s in store for construction sector over the next few years.

 

Let’s get the bad news out of the way first. We have been saying for some time that construction volumes are set to fall as the current round of private sector projects ends.

 

Recent building approvals data from the Australian Bureau of Statistics (ABS Cat no 8731) confirm what lies ahead in the next few quarters.

 

Firstly housing construction is edging up. Approvals for detached houses are up 10% compared with this time last year. However apartments and multi unit developments are down with approvals 38% lower. This reflects the tight lending conditions still in force.

 

The pick up in housing is not enough to outweigh the fall in multi unit developments in value terms.

 

The picture is even worse for non-residential building (offices, warehouses, retail, and so on). The year ending August 2009 saw only $18bn in building approvals compared with $29bn for the year ending August 2008. That’s an $11bn shortfall, which is only partially offset by a $3bn increase in public sector building approvals in the current period.

 

In other words overall construction is set to fall in the short term despite the best efforts of the stimulus packages and schools building programs. It is therefore important that the government continues its various stimulus packages and infrastructure construction.

 

Construction contractors will continue to compete aggressively for work and construction costs will stay flat during much of 2010. Pressure to win construction jobs will keep down subcontractors’ prices and preliminaries until the market recovers. Overall construction costs may even fall another percentage point or two helped by the strong Aussie$ and cheaper imported building materials. High exchange rates reduce the cost of imported plumbing fixtures, slates and granites, elevators and lifts, tools, vehicles, whitegoods, and furniture.

 

If construction is set to fall further, why is the RBA increasing interest rates and saying that the worst is now behind? The principal reason is that the current level of interest rates are “emergency rates”, intended to quickly stimulate the economy by giving households more disposable income. Low interest rates are great for households giving them more disposable income and creating the confidence to spend which boosts the economy. But house prices are very sensitive to interest rates.

 

With the cost of building new houses still way above the cost of buying an established house the RBA hopes to prevent a situation where established house prices increase too quickly whilst new house construction recovers only slowly.

 

This is a delicate balancing act because you would not want to kill off the fragile recovery in the new housing sector. However is now seems likely that interest rates are set to increase back to “normal” levels by mid 2010.

 

Fortunately the non-residential construction sector is affected far less by interest rate rises and its recovery will take place once the banks begin to relax their lending criteria, which we expect to see from now.

 

With Australia considered one of the survivors of the GFC, and with rising interest rates flagged it is no wonder that the Australian dollar is headed for parity with the US$.

 

The demise of the US$ is part of the reason. So also is the view that Asia is where the economic action is at present and Australia is connected to the Asian success story through its mineral exports. Australia represents a safe haven for foreign currency, that is open, democratic and relatively investor friendly. Also foreigners can borrow money in yen or US$ at 1-2%, invest it in Australian $ deposits at 4-5% interest and pocket the difference. The increase in demand for Australian $ from this so-called “carry trade” pushes up the Australian $. When they cash in their Aussie $ deposits back to yen or US$ they get more for their money from the better exchange rate.

 

The higher exchange rate is great for holidaymakers wishing to travel overseas. It also helps the retail sector with businesses such as Harvey Norman able to keep retail prices stable and import plasma televisions and computers at cheaper prices.

 

The high Aussie $ also makes repaying our extensive foreign debts a little easier.

 

But exporters suffer. Inbound tourism and the overseas student business decline, because other locations become cheaper. Those mining exporters locked into contracts with US$ prices suffer lower revenues.

 

Overall a lower exchange rate delivers a more balanced economy and better export earnings. It keeps out foreign competitors to domestically produced goods, stimulates local production, and makes our services sector (tourism, education, finance and engineering) internationally competitive.

 

2010 is going to be a year of consolidation and the start of recovery. Housing construction should continue to grow. Hopefully the banking sector will ease their lending criteria and private construction can increase again.

 

We are very optimistic of a return to strong growth conditions from 2011. The Liquefied Natural Gas sector is stirring, with the Gorgon project moving to construction in 2010 and other projects centred on Gladstone likely to commence construction in 2011. These are giant construction projects requiring thousands of engineers, contract managers, construction managers, project managers and tradesman.

 

LNG projects require extensive earthworks and civil construction, jetty construction, construction camps, pipelines, structural steel and tank fabrication. A large ecosystem of suppliers will spring up in the immediate vicinity.

 

The developments will move to construction just as the other sectors of the economy are recovering and we are very likely to experience the bottlenecks and capacity constraints that we thought the GFC had taken care of.

 

Once again we will be short of tradesmen and managers and we may need to resume strong overseas migration to meet the shortfall.

 

By 2012 the economy could be booming. By then construction costs will be increasing strongly again.

 

By Gary Emmett

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