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This article has been republished from the Your Investment Property digital magazine

Ethan Hyde, a real estate agent with Ray White Bundaberg, planned to add a swimming pool to his own home, approximately 9x4.5m. Based on the very similar-sized pool his friend had installed a couple of years previously, his expectation was that he would need to pay between $40,000 and $45,000. When he sought out a quote, he was told he would have to spend upwards of $60,000.

“We could make it cheaper, using fiberglass instead and less concrete landscaping, but this dramatic difference has made me rethink whether a pool is needed,” he told Your Investment Property magazine.

He isn’t alone. CoreLogic’s Cordell Construction Cost Index (CCCI), which captures movements in construction-related expenses, recorded an 11.9% increase over 2022, the highest on record. This includes the inflationary jump the introduction of GST caused in 2000.

Of course, those looking to build or renovate weren’t exactly the only group of people hurt by inflation last year. The Consumer Price Index (CPI), the common measure of inflation, surged throughout 2022, culminating in December when goods were 8% more expensive than the previous year. However, this comparison between the quarterly increases in CCCI and CPI shows construction costs saw significantly above-average levels of inflation.

What happened?

The pandemic disrupted supply chains in ways that could take years to become fully apparent. Manufacturers had to scale back their output during lockdown periods, and the materials that were produced were subject to increased delays and freight-related expenses. In the construction industry, both the number of workers on a site at any one time and the number of sites an individual worker could be at in a week were restricted, while the halt to migration quickly resulted in a dearth of qualified tradespeople.

At the same time, demand for new buildings and renovations took off. Commonwealth Bank reported a 15% increase in migration from capital cities to regional areas in 2020-2021 compared to the previous two years. This brought a surge in renovations and the construction of new homes, as Australians sought to take advantage of the more spacious regions. This happened while interest rates were at historic lows, fiscal stimulus packages were in free flow and house prices were quickly increasing. When you also consider the various natural disasters that have befallen Australians in the last couple of years, leaving thousands of homes needing repairs or to be rebuilt, it’s unsurprising that the Housing Industry Association (HIA) declared that Australia has never seen such a high demand for home building across all states.

Dr Diawasti Mardiasmo, Chief Economist at PRD Real Estate, further explained why Australia’s construction industry was particularly susceptible to inflationary pressure.

“We are quite reliant on China for our construction materials, and for a while China had its zero Covid policy, meaning that many of its manufacturing, plants, shipping docks, etc were regularly closed depending on COVID cases,” Dr Mardiasmo said.

This jump in price caused by the global scarcity of construction materials was also amplified by Australia’s geographical isolation.

“Sometimes cargo has to go through multiple docks to be able to get to us, which not only prolongs the journey but also increases costs,” Dr Mardiasmo continued.

Rate rises

In response, the RBA deployed its main weapon against inflation and rapidly hiked up the cash rate.

The goal is to contract demand to bring it more in line with supply, and bring prices down. For those looking to renovate or build in 2023 though, all the hikes mean is that they not only have to contend with exorbitant construction prices but also the heightened cost of borrowing money.

Inevitably, this has seen the number of planned new residential properties decline. There were 115,358 new houses approved in 2022, down 21.8% on the 147,552 the ABS recorded in 2021.

Tim Reardon, Chief Economist at the HIA, said this will likely not be the full extent of the drop-off.

“The adverse impact of the fastest increase in the cash rate in a generation will not be fully observed in building approvals data until later this year and will not hit building activity on the ground until late 2023,” Mr Reardon said.

“The significant pipeline of work that Australian builders are still completing, combined with ongoing materials and labour constraints, is creating significant lags between the RBA’s hiking cycle and on-the-ground activity.”

For Mr Hyde, the aggregate of all of this means he is facing prohibitively high costs for his renovations.

“Everything is tight and I believe it’s best to wait for this crunch to be over so prices will decline.”

Could the rent be worth it?

The drop-off in building approvals will likely exacerbate what many are already calling a rental crisis. Vacancy rates across Australia’s big cities are at historic lows, with houses on the market for record low amounts of time and hundreds of applicants chasing the same property.

Perhaps, therein lies opportunity. There is a severe shortage of rental properties, which means (altogether now) that rental rates are flying up.

This is one of the big reasons Dr Mardiasmo does not expect the rental market to be as severely squeezed as some are predicting.

“We have seen investors making a comeback, to capitalise on the previous historically low vacancy rate and higher rents,” she told Your Investment Property magazine.

She says this has already meant a slight uptick in vacancy rates, a trend she expects to continue.

It seems savvy developers might be willing to cop heightened construction and borrowing costs to take advantage of boosted rental rates.

The outlook

Undeniably, it isn’t an easy time to be in the market to build or renovate right now. While the cash rate increases should mean demand continues to cool, the supply issues are still being resolved, and it will take time for equilibrium in the market to develop once again. There’s also a very real risk that geopolitical instability will cause further disruptions to supply chains later this year (it’s not a giant leap to imagine that our relationship with China could continue to erode, for example).

For Dr Mardiasmo though, the construction industry has adjusted to the climate, and building or renovating in 2023 isn’t completely ridiculous.

“Many bigger builders and construction companies have innovated quite a lot in terms of how they structure contracts and source materials,” she told Your Investment Property magazine.

She said that it was important to manage expectations and be open to 'innovative or alternative ways to create the home you are looking for'.

“The key is finding a builder or construction company that will be transparent and open in their processes, with good communication for each step of the process.”