hia - housing activity during business cycles (august 2013)

7/27/2019 HIA - Housing Activity During Business Cycles (August 2013)

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Housing IndustryAssociation Ltd79 Constitution AveCampbell ACT 2612

p 02 6245 1393f 02 6257 5658hia.com.au

Housing Activity during Business CyclesAugust 2013

The purpose of this note is to explore the relationship between housing activity andother economic indicators during previous business cycles. Starting with the early

1980s, we consider four distinct business cycle phases consisting of an upturn,

downturn and recovery. The main findings are:

New home building tends to suffer disproportionately large declines during

economic downturns. It can take many years for activity to recover to pre-

downturn levels.

Activity in the renovations side of the market also tends to suffer during

downturns, but the pace of recovery is quicker than for new home building.

During downturns, residential construction activity has shown itself to be very

responsive to stimulatory policies like interest rate cuts and targeted fiscal

measures towards the industry.

The reduction of the taxation burden as well as reform in the areas of

regulation, planning and land supply would help strengthen new home building

activity following a period of considerable under-performance which now

extends for three years.

The chart below illustrates the development of quarterly Gross Domestic Product

(GDP) growth between 1980 and 2012. For almost all of this period, the economy of

Australia has expanded compared with the previous quarter. On only seven occasions

over this timeframe were reductions in GDP recorded, although recovery has tended to

follow quite quickly in most cases. The four business cycles explored in this paper are:

A: The early 1980s

B: The early 1990s

C: The introduction of the GST [mid 2000]

D: The Global Financial Crisis [from 2008]

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GDP Growth - relative to previous quarter (%)

Source: ABS

A BC D
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HIA Economics Group Note August 2013 Housing Activity during Business Cycles

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The Early 1980s

Figure 1 below illustrates the development of several indicators during the business cycle of the early 1980s.

For reasons of series continuity, detached home commencement numbers are used as the indictor of new

residential construction activity in this paper. The chart below shows how activity fared compared with thatindicators cyclical peak immediately prior to the downturn. It is important to stress that indicators did not

necessarily peak all in the same quarter. In fact, most indicators peaked in different quarters during the

downturn.

The early 1980s downturn was one that was replicated globally and had its roots in political instability in the

Middle East. The resulting surge in oil prices disrupted economic activity and led to a sharp escalation of the

inflation rate. Attempts to stifle inflation led to a hike in policy interest rates which further depressed activity.

Recovery eventually took hold when inflation and interest rates declined.

Prior to the early 1980s business cycle hitting a peak, the level of activity across most indicators grew

strongly. When the downturn kicked in, new dwelling commencements were badly hit. Commencements fell

by around 35 per cent relative to their peak within two years of the start of the downturn. Alternations and

Additions (A&As) to dwellings also fell off sharply, although not as severely as for new dwelling activity.

Non-residential construction fell sharply during the downturn, although not as steeply as new dwelling

construction.

Once the bottom had been reached, detached house construction and non-residential construction both

bounced back very strongly and had recovered to their pre-downturn peak within four years. The recovery of

A&As was much more hesitant; activity was still below its pre-downturn level a full five years after the onset of

the downturn.

Employment plays a crucial role in determining disposable income levels in an economy as well as generating

household confidence. Accordingly, major commitments such as home purchases and renovations will be

strongly affected by labour market developments. It is worth noting that during the early 1980s business cycle,

housing activity started to recover only when employment was again on the increase and after it had returned

to pre-downturn levels.

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Number of Quarters before/after Peak

Figure 1: Early 1980s Cycle Indicators

Detached House Commencements A&As Employment Non-Res. ConstructionSource: ABS


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Page 3

Figure 2 below provides a comparison between housing activity and mortgage interest rates during the early

1980s downturn. It is interesting to note that detached house commencements began their strong recovery at

almost exactly the same time as mortgage interest rates began to fall. Renovations activity bottomed out at

around the same time as the interest rate easing cycle began.

The Early 1990s

The business cycle during the early 1990s initially saw strong expansions in economic activity driven by the

deregulation of credit markets and a strong international backdrop. The emergence of inflationary pressures

resulted in interest rates rising internationally, a development which tipped most developed economies into

recession. Geopolitical tensions surrounding the first Gulf War and the disintegration of the Soviet Union

further undermined confidence and activity during this phase. Most economies started to recover quickly from

the downturn, but others including Australia endured a prolonged reduction in activity.

Figure 3 below provides an overview of housing activity and other economic indicators during the early 1990s

business cycle. Detached house commencements increased very strongly in advance of the peak in activity.When the downturn hit, activity eventually declined by over 30 per cent at its lowest ebb. Recovery was very

slow, with activity still stuck below pre-downturn levels a full five years later.

In contrast, the rise of A&As activity was much more gentle prior to the downturn. Following the peak of

activity, A&As fell by no more than 10 per cent and had recovered within two years of the downturn. This was

a particularly incongruous outcome given how badly employment suffered during the downturn of the early

1990s; numbers employed fell by 3.5 per cent during the height of the downturn and the pace of recovery was

extremely slow with employment taking over four years to return to its pre-downturn level. Non-residential

construction also saw a very sharp decline during the downturn followed by a very slow recovery.

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Figure 2: Early 1980s Cycle Additional Indicators

Detached House Starts A&As GDP Mortgage Interest Rate (RHS)Source: ABSSource: ABS


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During the early 1990s cycle, it is interesting to see how mortgage interest rates interacted with housing

activity. Interest rates rose in the run up to the start of the economic downturn. Once the downturn

commenced, mortgage interest rates embarked on a significant downward journey, illustrated in Figure 4

below. The A&As segment of the market responded quite strongly to the lower interest rates being in place.

Detached house commencements also responded well to lower interest rates, although the recovery fell farshort of pre-downturn levels. The weakness in new home building may be partly explained by the behaviour

of real house prices which surged in the lead up to the peak, but then declined by up to 10 per cent before

stagnating.

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Figure 3: Early 1990s Cycle Indicators

Detached House Commencements A&As Employment Non-Res. ConstructionSource: ABSSource: ABS

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Figure 4: Early 1990s Cycle Additional Indicators

Detached House Starts A&As GDP Real House Prices Mortgage Interest Rate (RHS)Source: ABSSource: ABS


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The GST Business Cycle

The GST business cycle was born out of the stimulus which followed the Asian financial crisis during the late

1990s. This was accompanied by reduced interest rates internationally and strong growth in several key

developed economies. The downturn was propagated by the escalation of interest rates and oil prices during2000, the collapse of the technology stock bubble, the 2001 terrorist attacks in the US and the subsequent

heightening of geopolitical tensions.

In Australia, the introduction of the Goods & Services Tax (GST) in July 2000 resulted in a large amount of

spending being dragged forward to the first half of 2000 and a sharp fall off in activity post July 2000. This is

illustrated in Figure 5 below. The associated effects on economic activity were substantial: detached house

commencements fell by almost 50 per cent in the immediate aftermath of the GST s introduction, with a

similarly sharp decline in non-residential construction. Motor vehicle sales also suffered to a lesser degree,

while the reduction in A&As activity was also more muted.

A&As had returned to pre-downturn levels within three years, but new home building was still significantly

lower five years after the start of the downturn. Indeed, detached house commencements have never fully

recovered to pre-GST levels at any stage over the subsequent thirteen years. Interestingly, the GST downturndid not involve any significant decline in employment. Rather, activity in the labour market stagnated for a few

quarters before resuming a growth trajectory.

The GST business cycle was also marked by strong housing price activity before and after the beginning of

the downturn. This is illustrated in Figure 6 below. Real house prices declined very slightly before the

economic downturn but quickly resumed a very strong growth path. Robust price developments were

probably supported by the lower interest rates in place after the start of the downturn. As was the case during

the early 1990s cycle, both new house building and A&As activity were responsive to lower interest rates. The

strength of housing price growth also contributed to the accumulation of home equity which would have

supported borrowing for home renovations, during a time of competitive and accessible credit markets.

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Figure 5: GST Cycle Indicators

Detached House Commencements A&As Motor Vehicle Sales Employment Non-Res. ConstructionSource: ABSSource: ABS


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The Global Financia l Cr is is Business Cycle

The GFC is widely regarded as the most serious global economic challenge since the Great Depression in the

1930s. Following the Asian crisis of the late 1990s, large global financial imbalances emerged involving high

savings rates in countries like Japan and China. The excess funds of these countries were recycled through

international financial markets with much of the cash being lent to the real estate sector in the US and parts of

Europe. The creation of complex financial instruments linked to securitised mortgage debt meant that

investors seeking low risk products unwittingly poured money into much higher risk areas. When this was

eventually discovered, investors realised severe losses on their investments. Some of these massive losses

on market instruments were insured, meaning that several major insurance companies were pushed towards

insolvency.

The inability to distinguish between high and low-risk debt securities resulted in lending activity in financial

markets grinding to a halt. The shortage of financing forced a severe contraction in economic activity in many

large economies. Over time, the crisis in financial markets spread to sovereign debt markets, with several

European countries entering bailout programmes through the International Monetary Fund (IMF). The

prolonged sense of crisis has prevented recovery from taking hold across the global economy.

Remarkably, Australias economy weathered the GFC storm quite resiliently. Figure 7 below shows the

development of several key indicators for Australia during the GFC cycle. In the run up to the GFC, detached

house commencements had largely been static. The beginning of the GFC downturn saw activity fall sharply

but a strong recovery in detached house building was prompted by the governments stimulus programme

and record reductions in interest rates. However, the withdrawal of the stimulus and interest rate increases

saw a second dip in detached house building. Similarly, A&As as well as motor vehicle sales saw smaller but

significant reductions in activity, especially A&As.

Non-residential construction activity initially weakened during the onset of the GFC but subsequently recorded

huge growth as the mining and natural resources (MNR) investment boom gathered pace. Non-residential

construction activity in this area was also strengthened by large-scale investment in the education sector and

in health infrastructure.

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Figure 6: GST Cycle Additional Indicators



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Interest rate and house price developments during the GFC business cycle are shown in Figure 8 below. It is

worth noting that both detached house commencements and renovations activity recovered strongly from

their initial falls and the era of low mortgage interest rates is likely to have played some role in this, in addition

to some of the factors mentioned above. The close relationship between renovations activity and real house

prices post-GFC is also worth noting. Declines in prices dampened the accumulation of home equity, therebyrestricting the scope for renovations financing.

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Figure 7: Global Financial Crisis Cycle Indicators

Detached House Commencements A&As Motor Vehicle Sales Employment Non-Res. ConstructionSource: ABS

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Figure 8: Global Financial Crisis Cycle Additional Indicators



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Conclusion

This paper reviewed indicators of economic activity in Australia over the past thirty years. For almost all of

that period, the economy grew and experienced mostly short-lived contractions on only a handful of

occasions.

The four business cycles examined here included phases of growth, contraction and recovery. Several

common features are discernible: first, residential construction activity tends to take a disproportionately large

hit during economic downturns, particularly new home building. Second, Alterations & Additions work tends to

recover more quickly than detached house construction and the magnitude of its recovery appears dependent

on house price growth. Third, new home building activity tends to take a very long time to recover once it

experiences cyclical decline.

These observations underline the vulnerability of the home building sector during periods of economic

weakness and demonstrate that strong policy support for the sector during cyclical downturns is warranted.

The experience of the GFC shows that stimulatory policies in the sector are capable of lifting activity but

also that abrupt withdrawal of such measures has the potential to tip activity back into decline.

In addition to the weak economic environment, there are a range of structural factors currently obstructing a

sizeable and sustainable recovery in residential construction, related to land supply, taxation, planning,

regulation, and a squeeze on credit. A focus on reform measures to lift residential construction activity is a

crucial area for policy development across all levels of government, and obviously needs to be led at a

Federal level.

hia - housing activity during business cycles (august 2013)

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