The impact of a housing sector downturn shouldn’t be underestimated

BY David Bassanese | 24 November 2015
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Signs are accumulating to suggest that Australia’s housing sector upturn is on its last legs. Yet due to the housing sector’s relatively small direct share of the economy, there is a risk that many analysts will underestimate the likely downside impact – which could be significant due to both the sector’s cyclicality and its relatively important multiplier effects.

Housing cycle near a peak

One obvious and timely sign that the housing upturn is losing its steam is Sydney auction clearance rates.  As seen in the chart below, weekly clearance rates have consistently dropped in recent months to be under 60% – compared with peak levels of almost 80%. Clearance rates are reaching levels at which Sydney house prices will likely stop rising before long. Along with growing land shortages and rising rental vacancy rates, flatter property prices will further undermine developer incentives to boost supply.

241115_Sydneys_changing_auction_market

Indeed, another emerging sign of weakness is building approvals.  As seen in the chart below, the real value of quarterly building approvals is already at a relatively high level and more up to date monthly approval data suggests that a peak has already been reached.  The chart suggests that the lag before a topping out in approvals feeding through into a downturn in housing construction is not especially long – at most one or two quarters.

241115_DwellingActivity

The economic impact could be significant

What impact will a peak in housing activity have on the economy?  One reassuring indicator is the fact the dwelling investment accounts for only around 5% of gross domestic product (GDP). The building construction sector – of which housing is only around 60% – also only accounts for 2% of employment.  The sector seems small beer – but it could be a case of the tail wagging the dog.

Indeed, there are two reasons the housing sector is more significant to the economy than these direct estimates suggest. For starters, the sector is one of the more volatile in the economy and its large swings in activity can have important contributions to the rates of change in economic growth.  As just one example, housing investment rose by 7.4% for the year to end-June 2015, which directly contributed 0.4pp (or one fifth) of the 2.0% growth in the economy.  Without that housing upturn, the economy would have grown by only 1.6%.

But even this underestimates the contribution of housing to the economy due to a second important factor – multipliers.  Past research from the Australian Bureau of Statistics (ABS) and the Reserve Bank of Australia (RBA) suggests the housing sector has especially important output multiplier effects though the economy because it relies a lot on intermediate inputs from other sectors to boost output.

According to RBA research[1], for example, every $1 of extra final demand in the construction sector in 2008-09 produced $2.31 of gross output across domestic industries compared with only $1.74 for the mining sector (see table below). Sectors that benefit most from a construction upturn include business services and manufacturing. Even older ABS research[2] – dating back to 1996-97 – suggested every $1m in extra spending on construction output directly and indirectly produced $2.9m in overall spending and 37 jobs.

What’s more, the home building sector tends to be a key exogenous driver of economic growth because its fortunes are less tied up in supplying intermediate inputs to other expanding sectors (as is the case for, say, business services), but rather on meeting the needs of end-user households and developers for new homes.

241115_Total_requirements_matrix
Source: see footnote 1

Allowing for multiplier effects, it’s quite possible the overall contribution to economic growth from the housing upturn over the past year has been around 2 to 3 times what direct estimates suggest. That implies the housing upturn could have contributed around half of the economic growth over the past year and a potentially even greater share of the overall rise in employment (and perhaps even more if we consider the potential link between housing prices and consumer sentiment, but more on that another time…)

Should the housing sector be nearing a peak, this timely contribution to economic growth will be sorely missed.


 

[1] RBA Research Discussion Paper 2013-02 Industry Dimensions of the Resource Boom: An Input-Output Analysis Vanessa Rayner and James Bishop

[2] Australian Bureau of Statistics Year Book 2002 The Construction Industry’s Linkages with the Economy