Why the high rise is not a tower of strength

Much of the growth in building approvals has come from low-cost, high-density developments, which are likely to have a muted effect on construction, jobs and the economy.

Building approvals continue to boom but residential investment remains weak. It will take some time for approvals to translate into construction activity, but when it does, it may not be as strong as many hope.

Building approvals rose by 6.8 per cent in January, much stronger than market expectations, to be around 35 per cent higher over the year. This followed three consecutive (but fairly predictable) falls from October to December.

Building approvals for both houses and units rose strongly in January, though building approvals for houses remains fairly low by historical standards. High density living, on the other hand, is rapidly rising in popularity and unit approvals have never been higher.

Graph for Why the high rise is not a tower of strength

The continued growth in building approvals will be a welcome sight for the Reserve Bank of Australia, which is relying on the housing sector to fill in some of the hole left by the impending decline in mining investment.

Residential investment will certainly pick up over 2014, but how strong are building approvals? Are we facing a residential construction boom? Probably not.

Building approvals have certainly improved but by historical standards they remain at a fairly low level as a share of the population. Approvals have a long way to go before they reach their level in 1999.

Graph for Why the high rise is not a tower of strength

A second important point is that much of the recent growth has been in higher density living. The construction of units is generally cheaper than for the same number of houses -- think economies-of-scale -- and also less labour intensive. 

Graph for Why the high rise is not a tower of strength

The rise in higher density living is an example of a changing social composition and the demand for inner-city living. However, it won’t provide the same boost to the economy that we would have seen in earlier cycles that were driven by approvals for detached housing. The construction sector will also not see the same boost in employment.

The RBA will certainly be happy to see that interest rates continue to have an effect on interest-rate sensitive sectors of the economy. But those who believe that the housing sector will do the heavy lifting for the post-mining boom economy may be left disappointed.

So far, little of the strength in building approvals has flowed through to actual construction activity. Consequently, I am bullish about residential investment in 2014. Beyond that, the outlook is uncertain. In addition, I anticipate that the pick-up in residential investment may not be as strong as we have seen in previous upturns as a result of a move towards higher density living.

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