Building boom set to bust

By BRIAN FALLOW

The building industry is heading for a downturn that will knock two percentage points off economic growth over the next two years, Westpac economists predict.

The construction sector tends to go through a rollercoaster cycle, swinging in recent years from annual growth of up to 15 per cent to contractions of up to 10 per cent. Even though it only accounts for 5 per cent of economic activity, that is enough volatility to throw the overall gross domestic product growth rate around.

Residential building represents about 60 per cent of construction work.

It is strongly influenced by house prices and the signals they send on whether it is cheaper to build or to buy an existing home.

In the year to March, house prices nationwide rose 22 per cent, outstripping a hefty 8.7 per cent rise in construction costs over the same period. The wider that gap, the greater the demand for new houses.

But because of capacity constraints, such as a shortage of tradespeople and the lags involved in getting building consents, it takes a while for new supply to catch up with demand.

"By the time new building activity reaches its peak, demand has often receded, which exacerbates the likelihood of a price correction on the downside," Westpac said.

"We are seeing evidence of this now with house sales slowing while new house building continues to rise. As house prices fall (or at least stop increasing) demand for new building will follow, reducing construction activity as the economics swing back in favour of buying an existing home."

Statistics New Zealand reported yesterday that the population grew 1.3 per cent in the year to June, down from 1.8 per cent the year before, a reflection of falling net immigration.

Westpac predicts a fall of 5 per cent in the national average house price over 2005. "If we assume construction costs rise by around 5 per cent over the same period then the fall in relative house prices [new versus existing] will be around 10 per cent."

Westpac's modelling suggests that will trigger a fall of around 15 per cent in construction activity. That would be consistent with previous cycles: construction fell 14 per cent in 1998 and 16 per cent in 2001.

A fall in house prices leads to a fall in building activity with a six-month lag, the full impact being felt after 12 months, Westpac economists said.

With net immigration expected to continue falling, they expect new house building to fall by $3.6 billion over the next two years, knocking up to 2 per cent off GDP growth.

That is despite an increase in non-residential construction from the Government and private sector.

And it does not include the spillover effects on suppliers of building materials and services, and reduced spending by workers.

"We expect GDP to rise 4.6 per cent in 2004 ... but as the combined effects of a slowing housing market and construction activity take hold we forecast GDP growth to fall below 2 per cent in 2005."