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Wednesday, 25 February 2015

Construction holds up well thanks to Ichthys

Total construction holds up

As I looked at here earlier today soft wages growth of 2.5 percent may have added to the case for another rate cut, but this was more than offset by than a better-than-it-have-been release for Construction Work Done in Q4 2014.

Construction work done in chain volume measures terms fell by only a seasonally adjusted 0.2 percent in the fourth quarter to be 4.8 percent lower year-on-year.

While more than $50.3 billion of construction work done is historically speaking a huge figure, this is now some 7 percent below the Q4 2012 peak of $54.2 billion, with further declines assured.

This decent result reduced the implied odds of interest rates being cut on Tuesday next week to ~42 percent, but markets still see another cut in the cash rate to 2 percent as close to a cast iron certainty by the middle of the year, with two cuts fully priced in by December 2015.

Let's spin through the figures in three short parts, where we shall see that Melbourne continues to construct far too many high rise units and apartments.

Part 1 - Construction by sector

Private sector building is picking up valiantly in response to low interest rates and rising house prices, but a lack of public sector spend as denoted by the moribund red line below is adding to the general malaise associated with the death throes of the mining construction boom (as denoted by the green line).

Engineering construction declined by only 0.6 percent in Q4 to be 12.1 percent lower over the year as we shall look at in Part 3 below.

The driver of building work done gains was exclusively a 12.7 percent year-on-year boost to residential construction, with non-residential building (largely comprising office blocks) acting as an irritating drag.

Drilling into the residential construction figures and we find that this boom is being pushed forward almost entirely by an unprecedented boom in the construction of attached dwellings - that is, units and apartments as circled below.

There is no sign here of the so-termed "renovations boom" (aka. "alterations and additions").

Sure, there is a bit going on in terms of major renovations in Sydney and Melbourne.

However, a "boom" is where numbers go up and contribute significantly to GDP growth...not when they flat-line for a decade before tailing back, thus acting as a drag on GDP.

Part 2 - State versus state

Moving down to the local economy level and it is no surprise to see that the two cities which have economies benefiting from the boom in residential construction are Sydney and Melbourne.

The strong economic multiplier associated with residential construction has helped these economies to flourish and created employment opportunities, and indeed, it is also these two largest capital cities which have also seen dwelling prices rising over the past six years, with almost everywhere else having done zip in real terms.

There is a flip side to this, of course, and that is that while Sydney desperately needs to construct thousands of dwellings to address a potentially chronic housing shortfall, Melbourne does not.

Indeed, as I have looked at here previously, Melbourne has possibly been over-building houses.

What is not in question is that Melbourne is most definitely overbuilding high rise apartments of 4+ storeys.

These things can take time, of course, but this will ultimately lead to a stagnation of rents and ultimately stagnating unit prices in this sector of the market as the oversupply takes hold.

As the chart above implies, Sydney has long since built out most of its prime usable space and constructs few houses relative to its population growth, with a fair proportion of them springing up in in awfully sparse fringe suburbs.

The below chart shows that Sydney has got its act together in respect of building units and apartments through this cycle - largely around the airport, the inner south and a few urban activation precincts which surround transport hubs - but this still won't meet the huge underlying demand over the next decade as the residential construction boom passes its peak in due course.

Brisbane, and to some extent Perth, are also cities which are in the process of building plenty of high rise stock. 

My advice is unequivocally to steer clear of off-the-plan high rise stock, since in aggregate there is clearly a looming oversupply.

Part 3 - Mining cliff deferred

Finally, there are evidently folk in Australia who are hoping for a mining bust in the belief that a recession somehow help us (or more specifically, them) to benefit from a "reset".

It has been a hollow victory to date with lower interest rates sending the ASX 200 soaring towards 6,000 and the highest index reading since May 2008.

Meanwhile dwelling prices are also comfortably set to break new highs over the year ahead as homeowners enjoy record low mortgage rates.

In the event a number of mega-projects such as Gorgon and Roy Hill in Western Australia - and more lately Ichthys in the Northern Territory - have temporarily suspended the decline of mining construction, so the Spumante will have to remain on ice for another three months.

The bulk of the mining capital expenditure decline, however, clearly remains in the post.

After some astronomical overruns and cost blowouts taking the total expected construction cost way beyond $50 billion, the Gorgon project is now reportedly 90 percent complete, so the brief respite for Western Australia appears likely to be be short-lived.

The INPEX Ichthys project is a huge $35 billion affair and the Northern Territory has seen an unprecedented $4.5 billion of engineering construction spend in the past two quarters months alone which has helped to stem the downward slide in resources construction nationally.

The next round of capex intentions surveys for Q4 have now been aggregated and will be released tomorrow morning - despite today's upbeat news, the smart money is still on "a horse named bust".

The Wrap

This was a solid result as compared to what might have been, and on balance shifts the odds very marginally in favour of interest rates staying on hold on Tuesday next week.

Sydney property owners must be licking their lips, with possibly another month or two for the full impact of the last rate cut to flow through to the rampant mortgage market, yet with two more cuts still fully priced in to cash rate futures markets by the end of the year.

Residex reported its January 2015 figures this week which showed quarterly house price growth of 1.7 percent for Brisbane, and Sydney's market accelerating, the harbour city recording quarterly house price growth of 4.1 percent.

The medium term outlook for Melbourne's property market is somewhat less rosy. 

A market can get along with overbuilding for so long, but - at the risk of crying wolf - this will eventually pull gross rental yields down to unacceptably low levels. 

With 3 year fixed mortgage rates available from an unbelievably cheap 4.18 percent investors will certainly accept lower yields than they once did, but there is only so far that these things can be pushed before something gives.


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