This article looks at the prospects for Australian construction 2010-2015

Key Points:-

During the period 2010-2015: -

·          Public works and commercial construction will slow down

·          Residential and resource construction will pick up

·          Skill shortages will increase, labour relations worsen and wages pick up as fly-in fly-out and overtime increases.

·          Exchange rate likely to hold up until developed economies' recovery (which will be tepid and slow)

·          Emerging Asian economies and Australian economy to remain strong driven by China.

·          Construction costs will remain flat during 2010 and 2011 as competition for private sector work remains fierce.

·          Construction costs will increase sharply during 2012-2015 driven by severe skills shortages, high levels of resource project construction and a recovery in residential construction.

Downturn less severe than expected

This time last year the prospects for the economy and the construction sector looked grim with the Global Financial Crisis still unfolding. Would we also experience what was taking place in developed economies worldwide i.e. 10% unemployment, a 40% fall in house prices, bank collapses and the end of the resources boom?

Now 12 months later those worst fears have not been realised in Australia. Unemployment sits at a very solid 5.3% a level which is considered nearly full employment. The construction sector has managed to weather the downturn without massive layoffs, thanks to the government stimulus packages of handouts, school buildings and insulation. These packages were quickly and successfully implemented, keeping overall construction afloat whilst private construction projects were being cancelled.

House prices have increased by 13% nationally. Commodity prices quickly recovered from March 2009 lows to levels at which new resource projects have become feasible again.  The announcement of major LNG and mineral projects has done much to improve confidence.

Our closeness with emerging Asia assures our quick recovery. In contrast many of our former trading partners in the developed economies face a very tepid recovery that could take up to ten years.

So where to from here?  

We expect construction activity to remain relatively flat in 2010 and 2011 and to gradually build up to boom conditions during the period 2012-2015. That will mean skills shortages, and capacity shortages, conditions which may be reminiscent of 2007. 

Examining the state of the various construction market cycles is useful in showing just how much construction work is likely to be undertaken. Construction activity is cyclical with alternating periods of boom and bust. Market cycles differ in duration and timing. When different market upswings become synchronised the impact is more pronounced. 

So let's quickly review the 5 year outlook for the key market sectors in Queensland, which include residential, commercial, public works and engineering (which includes mining and energy).

The GFC well and truly curtailed the commercial cycle, including office, warehouse and factory construction. During 2010-2011 difficulties in obtaining bank finance and lack of feasibility mean that this sector is set to ease as major projects finish. This market is likely to be moderately oversupplied for several years. The worst hit will be Brisbane and Perth where a flood of new supply driven by demand from the resources sector is still coming on to the market. In contrast Sydney and Melbourne, having less exposure to resources have oversupplied their markets less. Vacancy rates are still moderate in Sydney and Melbourne and consequently moderate recovery may be as soon as 2012-2015. Brisbane and Perth are unlikely to see expansion in commercial construction until much later in the decade, as vacancy rates start to fall again and rents rise to levels at which projects are feasible.

In contrast recovery in residential is gathering momentum with dwelling approvals up 30% in January 2010 compared with January 2009, and commencements up 26% year on year in December 09. Recently approvals for multi-unit residential have started to catch up.  The Reserve Bank of Australia will need to ensure that interest rates are not increased too quickly which could cut short the recovery. From a timing perspective Victoria and New South Wales are likely to lead the residential recovery.

Eventually the tough financial conditions imposed on residential development by the banks will ease as their exposure to poorly performing property loans is diminished and competition hots up. Residential construction is likely to keep increasing steadily from 2010 with a downturn possible by 2014-2105. The recovery in residential will also be dependant on the whether the government takes action to solve the difficulties created by slow approvals, land shortages and infrastructure charges. These factors are partly responsible for the worsening house shortage in New South Wales and Queensland.  

The timing of the increase in public works projects has also been beneficial in offsetting the GFC. With the ending of the Building the Education Revolution program during 2010 some major hospital projects such as the $1.4bn Gold Coast Hospital, $1.3bn Fiona Stanley Hospital and $700m Royal North Shore Hospital will pick up some of the slack. However public works are likely to lose traction from 2011 as the need to prepay government deficits becomes politically more important than building further infrastructure.

The Chinese Economy continues to power ahead despite a growing chorus of commentators calling it a "bubble". Our assessment of the Chinese project backlog indicates that the number of high speed train, nuclear power station, port, airport, road and electricity grid projects is still sufficient to underwrite Australian resource projects during the next decade. Coal, iron ore and Liquefied Natural Gas LNG projects will add significantly to overall construction activity in Queensland, WA and New South Wales.

Gorgon is a massive $43bn LNG project in WA. Perhaps the most exciting prospect for Queensland is the development of the coal seam methane industry with associated construction of LNG processing plants and pipelines. Building this industry involves up to $30bn in construction, and the final investment decisions are due to take place in 2010.  Whilst it is likely that some consolidation of projects will take place, through sharing of gas liquefaction facilities, much of the LNG is presold through very long term contracts. This raises the prospect that much of the investment will proceed. However building the pipelines, ports, and LNG trains will provide a major drain on construction skills. The demand for construction labour will increase dramatically consuming all available excess labour from neighbouring regions, and fly-in fly-out labour from  South East Queensland, South West WA and even Sydney and Malbourne. 

In addition to LNG, major coal projects including the giant Alpha Coal and Abbot Point projects are approaching construction spurred on by very strong coal prices and the need for China to start importing coal.

In summary, the commercial and public works sectors are set to wind down gradually during 2010-2015. However residential and construction of energy and mining projects are in the upwards phase. The extensive demand for skilled labour in the resource projects means that labour costs and construction costs are likely to increase dramatically from 2012. Should the residential sectors build sufficient momentum over the cycle from 2010 to 2014 Australia would be back to boom conditions, with the associated problems of costs and schedule blowouts. An early resumption of commercial construction in Sydney and Victoria could further compound the tightness of construction markets by 2013-2015.

What will happen to building materials and wages?

With the Australian economy linked to resource earnings exchange rates are likely to stay at the current high levels for much of 2010 and 2011. Low interest rates across the OECD countries will consolidate the strength of the $AUD especially as Australian interest rates increase. This means that tourism and the overseas student industry will suffer, with consequent impacts on hotel and university construction. Conversely retail is likely to benefit from cheaper wholesale imports and this may encourage some additional retail construction and refurbishment. 

Imported building material costs will stay low but those materials tied to commodity prices will increase. Steel prices have well and truly fallen from their 2008 peaks, bottoming in March 2009 but have since then recovered modestly. Over the period to 2015 Chinese demand for steel and a gradual resumption of demand in the developed economies mean that steel prices are set to increase substantially later in the period. Copper prices will also increase as per capita consumption of copper within China starts to approach the levels of developed economies, and the hybrid vehicle industry strengthens.

Wages will become harder to control with the strengthening demand for labour. The current level of unemployment conceals the swing towards part time work and shorter hours created by the GFC. This modest slack in the labour market will quickly be consumed during 2010 and 2011 and skilled labour shortages will see overtime payments increase.

Wages and building material costs did not fall during the GFC. The modest fall in construction costs experienced came from increased competition leading to reduced margins, and efficiencies created by a less frantic market.

In 1993 Australia had a severe recession.  Most construction sectors at that time were overbuilt, and the recession was the fizzing out of construction as prices collapsed. It took the rest of the nineties and the early part of the noughties until demand could recover again to kick off strong construction growth. Construction costs stayed flat. In contrast the period from 2000 to 2009 was a period of strong growth in construction output and construction costs, which could have continued for several more years had the GFC not occurred. In general markets have not been overbuilt and there is much left to be done, so the recovery from the GFC will be much quicker than occurred during the nineties.

By Gary Emmett