WHAT DRIVES HOUSING?
This article was contributed by Simon Tennent, Senior Economist, Housing Industry Association.
For many decades, the new home building industry has been one of the more volatile sectors of the economy. In the 18 months ending June 2001, however, the industry underwent one of the most dramatic and highly publicised boom-bust cycles in its history.
On the way up, the industry saw record levels of home lending and dwellings approved, record levels of industry employment and climbing trade prices as buyers rushed to beat the GST. On the way down, however, it shed more than 50,000 jobs, and contributed to some of the lowest GDP estimates in the past decade.
While the introduction of the GST could be regarded as an external shock, even without this one-off influence the industry will remain volatile due to its unique characteristics.
Like all mature industries, the housing sector is subject to slow growth and intense price competition. Volatility is manifested by activity fluctuating widely around its average growth rate. These fluctuations occur because the stock of 7,500,000 dwellings is large compared to the annual production of new homes - usually around 150,000 per annum. Thus a 1% shift in demand for housing can cause a 50% change in new dwelling starts.
So what drives this demand for housing?
First and foremost it is population - more specifically population growth, population movement, and population characteristics. According to the ABS quarterly publication Australian Demographic Statistics (3101.0), Australia's population over the past five years has been growing at an average rate of just over 217,000 persons (1.1%) per annum. Over 42% of this growth comes from net overseas migration - averaging 93,000 persons per annum. In new housing terms, Australia's growing population needs around 145,000 new homes each year.
In recent years, however, it has been the movement of population within Australia that has had significant consequences for the industry. Witness the flows between Victoria and Queensland, for example. Improving economic conditions and sentiment in Victoria over the late 1990s have drastically reduced the flow of population from that State to Queensland. Consequently, new housing activity in Victoria has grown by 60% while, at the same time, it has shrunk by 26% in Queensland.
The characteristics of the population are another uncertain variable for the housing industry. Much has been written and researched over the years about the implications of demographic change on housing demand. ABS figures tell us that divorce rates are rising, as is the number of single person households. The number of persons per household is falling, and people are living longer. Specifically for the industry we are seeing change with decreasing lot sizes, increasing floor areas, and an increase in the popularity of two storey homes. All of these things will continue to influence demand among Australia's new home buyers into the future.
From demography we move to economics - and in the case of demand for housing that means affordability, employment prospects, and consumer sentiment.
While the definition of affordability is often debated, essentially it is the capacity to pay - be it a mortgage or rent. For renters, the main ingredients here are household income (see for example the measure of household income in the quarterly publication Australian National Accounts: National Income, Expenditure and Product (5206.0)) together with median weekly rents. For home buyers it is household income, house prices, and the variable mortgage interest rate house prices are a product of labour, materials, fees, charges and taxes). Affordability, when plotted against house starts, has a clear and obvious relationship. When affordability improves, construction activity increases. In recent years, lower interest rates have put home ownership within reach of many more households. However, the ABS publication House Price Indexes: Eight Capital Cities (6416.0) shows that prices have risen accordingly. Currently, an average home loan absorbs 19% of average income.
Turning to the place of employment as a demand driver, when people have stable employment they are more likely to seek new houses. By plotting the ABS unemployment rate against ABS dwelling commencements, there is a clear long term correlation between the two - as unemployment rises, the number of dwelling commencements falls, and vice versa. This relationship, however, has faltered recently; unemployment has been creeping up at the same time as the First Home Owner's Grant has been boosting the housing industry from March 2001.
The last piece of the demand puzzle is consumer sentiment. While it is not something you can see or touch, it is vitally important in driving demand for housing. When plotted, the Westpac-Melbourne Institute Consumer Sentiment series also follows the home building industry very well. When sentiment falls in periods such as the Asian Crisis, rising interest rates, and the impending GST, the housing industry soon follows. This is soon reversed when employment picks up, interest rates fall and the economy shows strong signs of growth.
For the future, it is unlikely that these fundamental drivers will change, although at any time their relative importance will. Population characteristics will be the biggest challenge ahead for the industry as Baby Boomers retire, Generation X has families, and Generation Y leaves home. There is little doubt, however, that as long as people are employed and confident and dwellings are appropriate and affordable, the industry will continue to make a valuable contribution to the economy.