Home prices have surged in recent years, mortgage rates have moved higher and growth in household incomes hasn’t kept up.
As a result, housing affordability has deteriorated sharply hitting its worst level in at least three decades.
Despite the shortage of homes, the delivery of much-needed new homes has faced significant obstacles due to labour shortages, disrupted supply chains, and pandemic-related restrictions.
These challenges are compounded by a pre-existing array of difficulties, including delays in planning, limited land availability, and excessive bureaucratic processes.
These persistent delays not only slow down the building process but also contribute to higher construction costs, adding to the burden of inflation in building material prices and higher financing costs.
These challenges are contributing to the persistent housing supply deficit flowing through to both prices for existing homes and the rental market, fuelling continued upward pressure on home prices and rents.
Many are hoping that housing supply will lift to match strong demand, however per capita building completions and approvals are both at historic low levels.
Unless these challenges and cost pressures ease, delivering enough new houses or apartments will be difficult and we will continue to see the housing and rental affordability crisis worsen.
Since the pandemic, building input prices have increased 33.4% while output prices have risen 40.1% for houses and 23.2% for apartments. Although price rises have stabilised in the past year for input costs, build costs remain at a now higher level and continue to increase, albeit at a slower pace.
Higher labour, materials and financing costs compress margins, resulting in a potentially lower return on investment, which has delayed many projects.
Though growth has eased, the surge in labour, construction and financing costs has also pushed up prices of new builds.
Both established house and unit price growth in Sydney is lagging price growth of new builds.
This greater price inflation for new builds has increased the premium of buying new housing over existing stock.
This discrepancy in price between existing and new properties is another challenge for new development of both houses and units.
While there is strong demand for new housing, construction costs have risen so much that in many parts of the country replacement costs are more expensive than what existing homes are selling for.
This means in many regions buying an existing home in lower cost new build areas may have become more attractive.
In Sydney, most new house development is occurring in the 11 local government areas comprising Western Sydney. And in Western Sydney, the median price of new houses are currently listed at a 21% premium to existing houses for sale.
Potential investors and owner occupier buyers that may have looked primarily at Western Sydney’s new house and land market are likely also considering the established market, given the premium that buying new currently presents.
Of course, one advantage to buying new are the depreciation benefits which are at a maximum for new homes, meaning the greatest depreciation returns will be delivered by buying new houses or apartments.
And for first time buyers buying a new home will render those eligible the ability to access the first homeowner grant scheme which is not available for established homes.
This dynamic is evident in the unit market too, creating a difficult environment for the pre-sales necessary for property development finance.
Development financing is one hurdle to apartment commencements and this environment is making it increasingly difficult to get large apartment projects off the ground when we have a huge need for more supply.
This trend is also prevalent in other parts of the country, but the picture looks a little different in new development regions in Perth.
Strong price rises for existing houses over the past year has meant the gap has narrowed between buying new and existing.
Perth has been by far the strongest performing housing market in the country over the past year. It's no surprise then that of the suburbs seeing the strongest annual growth in home prices, Perth suburbs count for an overwhelming majority.
But interestingly, many of the suburbs seeing the strongest growth in Perth are in regions with lots of new development like Rockingham, Armadale, Kwinana, Wanneroo, and Mandurah. For example, median values for houses in Armadale have jumped almost 50% in the past year.
This could help spur better demand and pricing conditions for developers of new homes in Perth.
Against the backdrop of strong housing demand, the new homes market is also showing signs of accepting higher costs, though demand for new developments listed on realestate.com.au remains project specific.
Property views for new homes have risen by 9% this year compared to the same period last year, with enquiries up by 27%.
There are also glimmers of recovery evident in new loan commitments according to the Australian Bureau of Statistics (ABS), with a 6.0% month-on-month increase in lending for construction and 10.8% month-on-month increases to purchase newly built dwellings in April 2024.
This brings the value of new lending to purchase newly built dwellings up 22.4% over the year to April 2024.
It’s clear the cost to build is too high relative to the cost to buy established housing. This is hindering activity and creating a difficult environment for the pre-sales needed to finance large scale projects.
Aside from developers reducing margins, shifting this dynamic requires some combination of a moderation in the cost to build (material costs, wages, planning/approvals processes, land acquisition costs, productivity), lower cost of financing and/or continued house price growth.
While construction cost increases are normalising, they won’t be moving lower meaning market participants will need to adjust to this higher input cost environment.
Industry productivity, innovation and advanced manufacturing techniques have a role to play.
Australia’s construction industry is a productivity laggard. Construction productivity today is lower than it was in 1990, while labour productivity growth in the construction sector has also been low (0.3% per year) for more than 20 years, and is a fraction of that of the transport and manufacturing sectors.
However, in the near term the most likely lever to close this gap is continued price increases in the established market. Continued upward pressure on home prices will allow developers better pricing conditions and increase the viability of capital flows into building new homes.
This is just one reason why we expect home prices will continue to lift in the months ahead.
Efforts to ease development constraints, such as fast-tracking approvals processes, reforming planning and zoning restrictions, unlocking land supply, and increasing densities around transport hubs are both necessary and encouraging.
But until construction cost constraints improve and the gap between new and existing prices narrows, the material uplift in residential construction activity required will be difficult.
Continued price increases in the established market will allow developers better pricing conditions, increasing capital flows into building new homes.
As this premium narrows, cost increases stabilise further and interest rates begin to move lower, project feasibilities will improve precipitating the capacity to embark on new ventures. As a result a recovery in new housing supply should be underway, particularly given the current strength in demand for housing.
However, all these factors will take time to materialise in new approvals and subsequent new supply coming online, meaning upward pressure on rents and existing home prices will remain until new supply comes online.
