Housing Supply: How Long-Term Trends in Housing Construction Have Contributed to the Current Crisis

The mounting housing crisis has been a major factor in wider concerns about the cost of living in Australia. Challenges within the residential construction sector, notably a tight labour market and high material costs, have deepened this issue.

A lack of strategic planning for current and future housing needs, along with unexpected spikes in demand, has created a demand-supply imbalance. This affects many Australians, highlighting the need for strategic approaches to address and mitigate these challenges, ensuring that housing remains accessible and affordable.

The role of residential construction and public sectors in housing supply

It's generally agreed that national housing policy’s job is to provide adequate, affordable housing to meet the population’s needs. On the other hand, the private residential construction sector’s role is to maximise profit for its investors. These two objectives don’t generally align.

The private residential sector has little incentive on its own to produce adequate and affordable housing stock, especially not to the point of a reasonable oversupply that can protect against unexpected demand shocks. External factors like rising material costs, the availability of investment capital and labour shortages also influence the private sector’s operations. One-off events like the global financial crisis can reduce the private sector’s housing production, despite there being no reduction in demand for housing.

The fundamental gap between the objectives of national housing policy and the private residential construction sector is why we all generally accept that the government, in one way or another, needs to intervene in the market. The question is how, and how much. Specifically, there’s been an ongoing debate between supply-side and demand-side intervention over the past five decades, with the government increasingly favouring the latter during that time.

Trends in long-term housing supply

From 1947 to 1976, governments provided one-quarter of new homes, but by the late 1990s, this dropped to below 10%, shifting focus to grants for homebuyers instead of increasing housing stock. This led to a housing surplus decrease. As average household sizes shrank from 2.9 people in the 1980s to below 2.5 by 2019, demand for housing rose, with single-person households increasing from 18% of households in 1981 to over 25% – a trend forecast to continue.

Using population growth and average household size, we can calculate the basic minimum housing stock required each year. However, calculating the number of homes needed based on average household size doesn't fully cover demand. A surplus is required to allow people to switch residences and for new households to form.

Consideration must also be given to holiday homes, vacant investment properties, homes lost to disrepair and homes used for tourism, like Airbnb. Despite yearly construction typically meeting basic needs, the long-term surplus of homes has decreased, while demand for this surplus is likely increasing.

In the 25 years before the global financial crisis, Australia was building 0.66 new homes for every new person. Since then and up to the COVID-19 outbreak, that number has dropped to between 0.5 and 0.55.

In other words, demand for housing per capita is increasing while the rate of housing construction per individual joining the population has been declining for the past fifty years. As a result, the gap between the minimum number of homes needed and those actually constructed has significantly narrowed in the past ten years, in contrast to earlier decades. In recent years, platforms like Airbnb are likely further increasing demand for more housing.

This has created a housing market that is increasingly vulnerable to supply and demand shocks, worsening shortfalls and adding to the spiralling cost-of-living crisis.

Declining reaction times

A market that struggles to adapt to shortages or changes in demand has made today’s supply issues worse. As a tight labour market is likely here to stay, rapidly scaling up construction becomes difficult, even if material costs were to normalise and relieve input cost pressures on the construction sector.

Additionally, the best way to tackle a housing shortage and the trend towards smaller households is through constructing medium-density residential dwellings. However, these projects take a long time to complete, sometimes up to six years from approval to finish, which can lead to a lot of chaos in the interim.

An April 2023 report from Housing Australia suggested that new housing supply won't catch up with the rate of household formation until 2029, and will still face a cumulative deficit by 2033.

Social housing shortages

While the national housing stock increasingly struggles to avoid shortfalls, the social housing safety net has been wearing thin. Long before recent issues with housing costs, a study by the UNSW City Futures Research Centre found a deficit of around 200,000 affordable and available homes for the lowest income earners in 2016. A 2021-22 report from the Housing and Homelessness Data Working Group found that there was a 176,000-household waiting list for social housing in that year.

Social housing hasn’t expanded to keep up with population growth over the past few decades, making the problem larger. Since 2005, the social housing stock increased by only 14.5%, while the population grew by 29.0%. This gap has likely widened further with the recent housing affordability crisis since international borders reopened and pandemic lockdowns came to an end.

The government also provides direct assistance to private renters, but amid supply shortages this likely only leads to rental prices rising at the lower end of the market, in an environment already characterised by declining housing affordability

Demand versus supply

Australia’s buffer between housing demand and supply is generally leaner compared to other countries. The US housing market generally maintains vacancy rates of 5% to 10% on rental properties, while the Australian sector is currently sitting at around 1%, and even before our recent troubles never exceeded 4% nationally over the past four decades.

The global financial crisis highlighted a critical need for additional housing options. It underscored the necessity for increased public housing development, a responsibility that governments historically had a more active role in.

For example, government-built homes went from making up about 25% of all new homes to just 1% to 3%. Although Australia's population has grown significantly, the number of homes built by the government each year has decreased dramatically.

While giving out grants to help with affordability has its place, it doesn’t solve the bigger issue that construction companies aren’t building enough homes, especially not when the economy is weak, or when labour and building costs are high. The only way to ensure there are enough affordable homes is through government action to increase the supply.

Recently, governments have started to focus more on increasing the supply of homes as a response to the pandemic, rather than just trying to increase demand.

Industries impacted by housing supply trends

The recent housing crisis has encouraged state and federal governments to shift back towards supply-side intervention. There’s an increasing political drive to address the current crisis and it has the potential to fundamentally change dynamics within the Australian housing market.

Taking a long-term view, property developers, the banking sector and real estate operators should consider the possibility that new government intervention will rebuild the buffer between population growth and housing construction.

A bigger buffer in the coming decades may lead to slower growth in housing prices, an improvement in rental yields and a higher vacancy rate akin to other developed countries. This may impact the margins earned from mortgages, influence investment rental properties’ value and profitability and crowd out some investment from property developers. Companies making long-term investments in the residential property sector will need to take these risks into consideration.

Residential construction sector

Opportunities

The resurgence of supply-side strategies in the housing market presents a significant opportunity for the residential construction sector. With increased government funding and support for housing projects, construction companies stand to benefit from the growing demand for new homes.

This emphasis on increasing the housing supply is expected to facilitate innovation and technological advancement in the sector, leading to more efficient and sustainable building practices. These developments not only support the sector's growth, but also contribute to addressing housing needs more effectively.

Risks

Despite its opportunities, the residential construction sector navigates several risks. A reliance on government policies and contracts for growth subjects companies to potential shifts in political priorities and funding.

Moreover, labour shortages and rising material costs have been challenging the sector. These factors threaten profit margins and projects’ viability amid unpredictable market conditions. This scenario underscores the importance of strategic planning and adaptability for companies aiming to thrive in this environment.

Key success factors:

• Investing in workforce development and training is a strategic approach to mitigating labour shortages. By cultivating a skilled and adaptable workforce, businesses are better equipped to meet new challenges head-on. Additionally, embracing technology, particularly building information modelling software, for project management can enhance efficiency, streamline operations and lead to cost savings.
• By integrating green materials and designing for energy efficiency, companies not only respond to growing consumer and regulatory demands for sustainability but also gain a competitive edge in the market. This approach aligns with environmental objectives and offers a distinct advantage, showcasing a commitment to innovation and responsibility.
• Forming strong partnerships with government agencies, suppliers and other stakeholders is crucial for construction companies seeking enhanced access to funding, information and resources. These partnerships are vital to successfully managing both public and private housing projects and capitalising on chances for expansion.

Banking sector

Opportunities

New supply-side interventions in the housing market offer banks a prime opportunity to boost lending activities and grow their mortgage portfolios. An increase in available housing will likely drive up demand for mortgage products, resulting in higher lending volumes and potential revenue growth for banks.

By broadening their range of mortgage products to meet different homebuyers’ needs, banks can increase their market competitiveness and elevate customer satisfaction. This approach supports growth within the banking sector and also enriches the housing market, making it more responsive.

Risks

While the housing market offers opportunities, it also comes with risks due to its fluctuating nature. A potential slowdown in housing price growth could reduce mortgage portfolios’ profitability, which, in turn, might affect banks’ financial performances.

Economic uncertainty and possible market corrections could lead to loan defaults. It's essential for banks to implement careful risk management practices to minimise potential losses, focusing on strategies that’re both effective and responsive to changing market conditions. This approach ensures that they can navigate these challenges while continuing to support their customers and communities.

Key success factors

• Banks should focus on diversifying their mortgage products to cater to different segments of homebuyers. By offering a range of products tailored to various needs and financial capabilities, banks can enhance their market competitiveness and attract a broader customer base.
• Given the housing market’s fluctuating nature and the potential risks associated with supply-side interventions, banks need to implement robust risk management practices. This includes closely monitoring market conditions, assessing borrowers’ creditworthiness and adopting proactive measures to mitigate loan defaults.
• Banks can boost customer engagement and loyalty by focusing on homebuyers' needs, offering affordable and eco-friendly financial products, personalised advisory services and a smoother mortgage process through the use of technology.

Real estate operators

Opportunities

A shift back towards supply-side interventions could lead to more real estate transactions and heightened market dynamics. As the housing market becomes more stable, real estate agencies may see an increase in commission revenue due to a higher number of property transactions.

Moreover, growth in rental properties, fuelled by a larger housing supply, presents opportunities for property management services. This could allow for greater diversification of revenue sources, benefiting the sector as a whole.

Risks

Market volatility and government-mandated regulatory changes present challenges for real estate operators. A slowdown in housing price growth can affect real estate agencies’ revenue models, which depend largely on commissions.

New government regulations can also influence real estate businesses’ operations and profitability. To manage these challenges, it's crucial for firms to adopt proactive compliance strategies.

Key success factors

• As the political landscape increasingly favours supply-side solutions to address the housing crisis, it's important for real estate agencies to be adaptable. This means keeping a close eye on and fully understanding any potential shifts in policy and regulation, like housing construction incentives or changes in zoning laws, and then aligning business strategies to match these changes.
• In anticipation of a potential slowdown in housing price growth and increased market stability, real estate agencies should explore diversifying their revenue streams beyond traditional property sales. This could involve expanding into related sectors like property management services for rental properties or offering ancillary services like renovation and maintenance.
• It’s important for real estate agencies to embrace technology and innovation throughout their operations. This includes leveraging data analytics for market insights and implementing digital platforms for project management and customer engagement.