Residential Construction and the Finance Process

This article provides an overview of the dwelling construction and finance process, and how specific events are recorded in the following Australian Bureau of Statistics (ABS) data series: Lending Indicators, Building Approvals, Construction Work Done and Building Activity. It also describes how government grants, such as HomeBuilder, interact with the construction and finance process, and how such grants will impact ABS statistics.

There are two common scenarios when constructing a new dwelling: 

1. the land is purchased, and the owner enters into a building contract with a builder (includes "house and land" packages); or
2. the owner purchases a dwelling "off-the-plan" from a developer (also known as a "turnkey" package).

The key difference is that in scenario (1), there are usually separate contracts for the sale of the land and the construction of the dwelling. In (2) they are bundled into one contract, and settlement occurs when construction is completed and the dwelling is ready to be occupied.

Typically, when money is borrowed to construct a new house, the land and construction components will be financed in separate loans: 

• The vacant land loan is similar to a loan for an established dwelling, where a deposit is required from the prospective owner and the funds are released on the day of settlement. At this point, the ownership transfers to the buyer and they begin repaying the loan for the land. 
• Construction loans, on the other hand, are usually paid to the builder in stages, at key milestones in the construction process (e.g. foundations laid). 

Table 1 below outlines the process when the land and construction components are financed separately. It also indicates where key events are recorded in ABS construction and finance statistics.

*Note that the event may contribute to multiple series in a range of tables. For brevity, the key series are listed here. 

The graph below presents the number of private sector houses approved and the number of new borrower accepted commitments (i.e. loan application approved by lender and accepted by the borrower) for the construction of owner-occupier dwellings (seasonally adjusted). While there are some important scope differences between these series, there is some overlap between them, as we expect that (a) a large portion of new private sector houses are occupied by owner-occupiers, and (b) the majority of construction loans are used to build private detached houses.

There is moderate statistical correlation between these series, which becomes stronger if the lending series is shifted forward in time. The strongest correlation between the two series is when the lending series is shifted forward by three months (see Appendix for further information). This suggests that borrower accepted commitments for construction arise about three months before building approval is granted.

In the Lending Indicators publication, a borrower accepted commitment is reported when the borrower signs the formal loan offer from an authorised deposit-taking institution (ADI). Council approved plans are not required by all ADIs prior to loan approval, however the plans must be provided before the first progress payment is drawn (usually on completion of the foundations). This supports the statistical analysis above. That is, the borrower accepted commitment is likely to occur before the building approval is issued. Also contributing to the timing difference is that around 5% of building approval records received by the ABS are approved prior to the reference period e.g. a record that was approved in May, but only supplied to the ABS in the June reference period. The late provision of building approval records can occur, for example, when the building approval has been privately certified, but the council is not notified of the decision until weeks or even months later. 

There are important differences in scope between these series that means the number of dwellings approved from month-to-month is substantially larger than the number of construction loans to owner-occupiers. Reasons for this include:

• The dwelling may be owned by an investor - a new data series collected since July 2019 shows that investors have accounted for around 25% of all new loan commitments for the construction of dwellings. This figure is likely to vary over time depending on broader investor activity; 
• The dwelling may be owned by a private business, and cannot be purchased by the occupant e.g. retirement villages and build-to-rent developments;
• Where one loan commitment is provided to fund the construction of more than one dwelling, such as for a new dwelling and granny flat, or building two dwellings on one parcel of land, one for owner occupation and one as an investment property;
• The owner may be able to pay for construction outright, without a loan; or
• The source of the loan is not an Australian ADI (e.g. funded by a foreign lender).

Off-the-plan purchases are most common in apartment developments, but can apply to low/medium density developments (sometimes referred to as a "turnkey" package). 

A key difference between the previous scenario and off-the-plan purchases is the timing of settlement. In off-the-plan developments, the prospective owner will typically pay the builder a deposit prior to construction commencing, with the balance payable on completion of the dwelling. Since the developer is not receiving payments from the prospective owners through a construction loan as work progresses, the developer may need to arrange their own finance to fund the project. 

Table 2 below outlines the construction and finance process for off-the-plan developments, assuming the prospective owner signs the contract of sale prior to the commencement of construction. The developer will usually fulfil a certain number of pre-sales prior to commencement, meaning some prospective owners may enter into a contract with the developer during construction or post-completion.

*Note that the event may contribute to multiple series in a range of tables. For brevity, the key series are listed here. 

The borrower accepted commitment for the purchase of an off-the-plan dwelling often occurs at a similar time to the completion of the dwelling. Therefore, there is some alignment between the number of loan commitments for the purchase of newly erected dwellings in Lending Indicators, and the number of dwellings completed in Building Activity (noting the scope differences outlined in the previous section apply here also). Notably, off-the-plan projects may be represented twice in the Lending Indicators publication: firstly as a loan to businesses prior to construction commencing, and again as a loan to the new owner at settlement.

There are a range of federal and state-based incentives available to owners who are constructing a new dwelling or renovating their place of residence. 

Most states and territories offer First Home Owners Grants (FHOG) to first-time property owners. The eligibility varies by jurisdiction, but often the prospective first home owner must either purchase an existing home that has not been occupied previously, or construct a new dwelling. There is usually a condition that the first home owner must occupy the dwelling as their principal place of residence for at least six months, therefore excluding the use of the new property as an investment initially. FHOGs are usually paid on settlement if purchasing a new home, or when construction commences if building a new home. Whether customers can use the FHOG as a deposit varies across lenders.

In 2018, the Australian Government introduced the First Home Loan Deposit Scheme to assist eligible first home buyers to purchase a home sooner. Up to 10,000 places were made available in each of the 2018-19 and 2019-20 financial years, which could be used to purchase an existing home or construct a new home. Under the scheme, a home could be purchased with a deposit as low as 5% of the value of the property. Usually, home buyers with a deposit that is less than 20% must pay lenders mortgage insurance. Instead, the Australian Government acts as the guarantor for the difference between the deposit and 20% of the property value. As part of the 2020-21 Federal budget, the Australian Government announced an additional 10,000 places for the scheme, however it is now only available to those who build a new dwelling or purchase a newly built dwelling.

In response to the COVID-19 pandemic, the HomeBuilder program was announced by the Federal Government on June 4th, 2020. It provides eligible owner-occupiers with a grant of $25,000 to build a new home, or substantially renovate their existing home. The building contract must be signed prior to December 31st, 2020, and construction must commence within three months of the contract date (extended to six months in Victoria).

Table 3 provides details of key ABS series that are impacted by these government grants. 

The table below presents the correlation coefficients for the number of private sector houses approved and the number of new borrower accepted commitments for the construction of owner-occupier dwellings (seasonally adjusted), after shifting the lending series forward in time by an offset. This gives a sense of how many months it takes for changes in lending patterns to become evident in approvals data. This technique is known as "cross correlation". 

The first row in the table is the correlation coefficient when the series are compared at the same point in time. In the rows thereafter, the lending series is shifted forward by up to seven months.

Higher correlation coefficients imply a stronger positive relationship between the two series. The correlation coefficients are quite similar when the lending series is shifted forward by between two and four months, with the highest occurring at three months. This suggests that borrower accepted commitments for construction arise about three months before building approval is granted.