Building and Construction Outlook quarterly report - May 2011 quarter
Construction sector awaits recovery
Contents:
Key Themes - May 2011
- 2011 started on a weak note for the building and construction sector after a disappointing end to last year. In mid-2010 a hesitant recovery seemed underway in the residential sector, and it was expected that this recovery would pick up speed and spread to the non-residential sector. This did not happen, and in the third quarter of 2010 residential consent figures were low again. They then dropped further in the fourth quarter of 2010. In the first three months of 2011, residential consents were at their lowest levels since records began.
- The short-term outlook for the non-residential sector is weak. Non-residential consent levels in the first half of 2010 were low. This indicates that building activity for mid-2011 will also be low. Improved consent levels in the second half of 2010 suggest that activity levels may stabilise or pick up slightly in the second half of 2011.
- Looking ahead, the repair and rebuilding work arising from the 4 September and 22 February Canterbury earthquakes will provide a boost to the building and construction industry. Damage to the residential sector has been estimated at $9 billion by the Treasury. Residential repair and rebuilding work is expected to begin in earnest late 2011 and then continue for five years or more.
- Earthquake damage to the non-residential sector is extensive with current Treasury estimates at $3 billion for commercial and $3 billion for infrastructure. However, the timing and extent of the repair and rebuild work is not clear. Few CBD building owners will be in a position to make major repair or rebuild decisions before the end of 2011 and this will delay building and construction work. Key factors in that decision-making will be insurance coverage levels and timing of insurance payments. Rebuild will be limited where there is underinsurance or demolition work to be done, and indications are that these are concerns. In addition, decisions on future land use will impact on rebuild opportunities.
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Non-residential building outperforms residential
- Non-residential building activity continues to be more resilient than residential. The seasonally adjusted value of non-residential building work put in place rose 10.6% in the December 2010 quarter and 18.8% over all of 2010. This was driven by a surge in health and possibly Rugby World Cup related work. However, the outlook remains subdued. New Zealand businesses are continuing to reduce debt, even in those industries that are performing well (such as agriculture). This is creating a spending-averse business market and this hampers growth. Non-residential consents have stabilised at a low level. This means construction activity will be slow in 2011, before a stronger cyclical recovery in 2012, which will be further supported by rebuilding activity in Canterbury.
- Residential building activity declined in the second half of 2010 and this has continued in early 2011. The amount of seasonally adjusted residential building work put in place fell 7.1% in the December 2010 quarter, following a 5.9% drop in the previous quarter. This reflects a low number of residential consents in the first half of 2010. Dwelling consent numbers hit historic lows in early 2011. This will depress construction activity until the end of 2011. Prospects of a 2012 recovery are improving, supported by the Canterbury rebuild, low interest rates and emerging evidence of reviving demand seen in rising house sales.
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Residential weakness persists
- The total annual number of residential consents for the year to March 2011 was 14,611, which is 31.9% lower than the average for the previous five years (21,459). The first three months of 2011 were all low. January residential consents were only 867, the lowest amount for any month since records began in 1965. February consents numbered 973, and March 1,087.
- The residential construction industry had been operating well under capacity prior to 2011, so the drop in consents is largely a demand problem. Unemployment, low wage growth, and general economic uncertainty are continuing barriers to demand. Lower interest rates have helped to stabilise home lending, but sales have remained low compared to historical levels leading to a large inventory of unsold homes. If this situation persists and leads to a reduction in home prices, there will be less need for prospective homeowners to build rather than buy.
- Housing demand is forecast to increase by 20,000 households per year due to a combination of population increase and a long-term movement towards smaller households. Most of this increase will be in Auckland. Current consent volumes are below the level needed to meet that demand and this will lead to a housing shortage in the future. However, residential investment is primarily driven by current demand, not future, and this remains relatively low.
- There may be some positivity in the residential sector even before the Canterbury rebuilding work gets fully underway. The rebuild is expected to lead to some increases in building costs as both labour and materials become scarcer and interest rates rise. Some builders may choose to advance projects to avoid possible higher costs and take advantage of the current low interest rates. Residential building clients may also be motivated to move projects forward to save on costs.
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No help from migration
- Immigration is unlikely to boost housing demand in the near future. Net migration turned slightly negative in March (-100) and April (-510) as departures exceeded arrivals, when usual seasonal patterns are excluded. The increase in departures was mainly from Canterbury, and was most likely related to the earthquake.
- In March and April there were 1,400 and 999 international departures respectively by Cantabrians compared to a monthly average of 654 in the year ended February. Although clearly brought upon by the February earthquake, it remains uncertain whether this is a one-off event or a trend that will continue.
- The number of New Zealanders moving to Australia over the last year has had a large impact on migration. In the March 2011 year, 36,100 Kiwis departed to Australia, up 36.7% from the March 2010 year and 19.5% above the average of 30,204 over the past 10 years. In addition, fewer New Zealanders living in Australia are returning home. This may impact on home ownership demand as New Zealanders returning from overseas are particularly likely to purchase homes. This trend is unlikely to reverse in the near-term as Australian unemployment (currently 4.9%) is projected to stay relatively low and the Australian dollar expected to remain strong through 2011.
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Interest rates drop
- The Reserve Bank cut the official cash rate (OCR) by 0.5% to 2.5% on 10 March in response to the potential economic impacts of the February earthquake. The Reserve Bank also cited lower than expected growth prior to the earthquake as a contributor to the rate cut. The rate change is intended to stimulate economic growth across New Zealand, including earthquake-affected Canterbury.
- Retail mortgage rates had dropped even before the OCR announcement as the rate cut was widely anticipated. At the end of March, the average floating mortgage rate for new customers was 6.2%, compared to 6.5% at the end of December. One-year rates were almost the same at 6.1%, indicating banks expect rates to remain constant through early 2012. Lower mortgage interest rates appear to have halted the decline in mortgage lending and may spur a recovery going forward.
- Based on the Reserve Bank's March Monetary Policy Statement and further comments in April, most commentators do not expect the OCR to rise until late 2011 or early 2012. At that time wages are expected to rise, particularly in construction as the earthquake rebuild gets underway. Rising wages may prompt the Reserve Bank to raise the OCR in order to counter inflation risks. The rise would be unlikely to impact the rebuild. However, it would increase loan costs for other residential and commercial building.
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Home lending stabilising
- The home lending market began to stabilise in early 2011 despite record low volumes of house sales. The number of new home loans in the first quarter was down only 6% on the first quarter of 2010. This is a much smaller annual decline than the third and fourth quarters of 2010 which were down 25% and 17% on the same quarters of 2009.
- While the number of home loans is stable, the total value of loans is increasing. In the week ended 1 April 2011, $896 million in new home loans were approved. This was the largest value for any week since 2009. The rise in total value was largely due to an increase in average loan size beginning early February. This was likely to have been caused by more house sales in Auckland and a favourable lending environment, rather than an increase in house prices.
- According to the Reserve Bank of New Zealand's Financial Stability Report, banks have softened their household lending criteria. This may be to encourage home buying in the weak housing market. With interest rates expected to stay at historic lows through most of 2011 and then begin to rise, banks will remain eager to attract borrowers before rates increase.
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Non-residential steady but vulnerable
- Non-residential building was low in 2010 compared to the peak years of 2006-2008 but improved from a steep decline in 2009. Non-residential building work put in place was steady throughout 2010, with $1.13 billion, $1.18 billion, and $1.18 billion in the first three quarters of 2010 respectively in seasonally adjusted terms. The fourth quarter was slightly stronger with $1.31 billion.
- Non-residential consents had a poor start to 2011 with first quarter consent numbers the weakest since the June 2004 quarter. Consents are generally a reliable 12-month leading indicator of building activity, so this suggests building activity levels for the remainder of this year and early 2012 will be weaker than 2010. Earlier-than-expected commercial rebuilding in Canterbury could speed up the recovery.
- Consents for most non-residential building categories having either declined or held steady over the past few years. The weakness has been most profound in private sector dominated segments such as farms, office, retail and industrial. In contrast, health and particularly education has been strong as the government fast-tracked public sector work. The value of consents for education buildings has increased in each of the past four March years. The $710 million in education building consents issued in the March 2011 year was 19.1% of all non-residential consents - over the previous five years it averaged only 12.1%.
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Glimmer of hope for house sales?
- House sales remained sluggish early in the year, with record low sales in January (3,252) and February (4,502). However, March was comparatively high with 5,848 sales. While this was a decline of 5.1% on March 2010, it is the smallest year-on-year decline for any month since February 2010. Even with the strong March, year-to-date sales were 55,049 - down from 68,857 in the March 2010 year and roughly the same as the March 2009 year (55,013), the lowest March year on record.
- The relatively high number of March sales was driven largely by a surge in the Auckland market where sales were 2,437. This was an increase of 11.4% on March 2010 and ran counter to the national trend. Auckland sales were 42% of the national total in March compared with 35% over the previous year. The rise in sales in Auckland accounted for 62.9% of the national March increase on February.
- The inventory of unsold properties fell to 51,980 in March from 53,077 in December. This drop was a result of fewer listings as opposed to more sales. The number of unsold properties amounts to 53 weeks of inventory.
- The earthquake disrupted the housing market in Canterbury and March house sales were down 45.2% from March 2010.
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House prices remain flat
- House sale prices were stable over the first quarter of 2011. The March median sale price of $365,000 was up only 1.2% up on the previous year. Even this increase was inflated by the larger proportion of sales being from more expensive Auckland. Despite the quiet market, sellers appear reluctant to lower their asking price - averaging $421,940 in March, only 0.2% less than a year prior.
- It appears that neither buyers nor sellers are in any hurry to deal at the moment. Continued flat prices and large inventories are likely to make buyers feel there is little risk in waiting to see if prices drop, while low interest rates make it easier for current owners to service their mortgages. Consequently, the market remains mostly stagnant, while showing recent signs of life in a few locations, primarily Auckland but also Waikato and Otago.
- There is no clear impact on house prices in Canterbury after the February earthquake. The median sale price was $290,000 in March, unchanged from February, although this value has been derived from an unusually low number of sales (see previous section). Some long-term effect on prices is likely, but the uncertainty around migration makes it impossible to say what that effect will be.
- Flat house prices and low interest rates have aided home affordability. The latest Massey University Home Affordability Report stated that home affordability improved 5.2% in the February 2011 quarter as wages continue to grow faster than house prices. Additionally, the February quarter edition of the Massey Index will not have accounted for the March decrease in interest rates. This should improve home affordability further.
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Auckland rents stable
- There has been widespread media coverage reporting rental shortage and a rapid price rise in the Auckland rental market. Although there is little reliable information on vacancy rates, reports from TradeMe and First National have pointed to a tightening of the Auckland rental market. If this is true, it has not shown up in market rent rates. Private rents in South Auckland and Central Auckland rose 2.4% and 1.0% in the first quarter respectively; both typical movements. Rents in North Auckland fell 4.4% in the first quarter.
- Nationally, rents were up 3.1% in the first quarter and 6.0% for the year to March. These are modest rises considering the weakness of rents in recent years. Over the three years to March 2011 rents rose 8.1%, less than inflation over the same period (9.8%).
- In the September quarter 2010 Building and Construction Outlook Report we forecast that rents could be set to rise as landlords compensated for lower capital gains. Tax changes affecting property investors were seen as adding to the upward pressure on rents, a view shared by Westpac economists. Since September, rents have undergone only a small rise (4.0%). A possible explanation is that landlords may be absorbing the costs themselves in an attempt to hold on to tenants.
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Commodities driving cost rise
- Construction labour costs remained subdued in the 1st quarter of 2011. The Labour Cost Index (LCI) for construction rose only 1.9% in the March 2011 year, much less than inflation over that period (4.5%). Low employment levels continue to keep wage levels flat. This will probably continue until earthquake reconstruction work drives up labour demand from 2012.
- Building materials costs have begun to rise. The Producers Price Index (PPI) for construction inputs, which includes costs for machinery, materials and services, rose by 3.7% in the March 2011 year.
- A strong New Zealand dollar has partly offset strong global commodity price increases, such as steel and crude oil. Global commodity prices have been volatile recently, affected by increasing uncertainty on the global growth outlook.
- Although some of these price changes may be temporary, increased international demand, particularly from developing nations, is not. New Zealand is a small market, which makes negotiating good prices more difficult. In the face of increased demand from Asia and major post-disaster rebuilds in Japan and Australia, building materials prices will likely continue to rise over time. The advantage for builders with more efficient purchasing and use of materials will also increase.
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Fewer workers, more hours
- There were 164,700 people employed in the construction industry in the March quarter, according to Statistics New Zealand's Household Labour Force Survey. This is a decrease of 8.2% on the December 2010 quarter and is the smallest number of people employed in the industry since June 2005. Despite the drop in employee numbers, the number of hours worked actually increased by 6.0% in the March quarter. We have not seen a gap this wide since 1998, 13 years ago. This suggests that available work and labour are not well aligned in either location or sector (residential, non-residential, or infrastructure). This means workers in certain locations or sectors are working longer hours, while workers in others cannot find a job.
- Sustained lower levels of employment are concerning. If building and construction workers currently unable to find work move permanently to other industries or leave New Zealand, we could face challenges in meeting local labour supply demand as Canterbury rebuild gets underway later this year and in 2012. Even if rising wages lure workers back to New Zealand or to construction, this will be a delayed response and firms may lack the necessary capability in the meantime.
- While we are unable to determine the number of people who have moved to other industries, we can estimate how many have departed New Zealand. In the March 2011 year, 757 more workers in construction-related fields departed the country than arrived. This represents less than 1% of industry labour capacity, so there has not yet been a major impact. However, there was a loss of 252 in March alone, and if that level of departures were to continue for long, there could be a meaningful decrease in industry capability.
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Published in May 2011.
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