Construction costs increases have been a major driver of inflation and a big problem for housing supply. Construction cost increases peaked in July 2022, rising by 21 per cent over the 12 month period. In Brisbane, the most impacted city, the increase exceeded 30 per cent. 

While there continue to be a lot of challenges in building homes where people want to live, construction costs were a major restriction to the number of new homes built. Last year, Australia’s population increased by 500,000 people, requiring around 200,000 additional homes. Only 172,000 were built. 

This imbalance between supply and demand showed up quickly in rental growth in 2022 but by the start of 2023, it was also driving up house prices. Too few homes led to a shortage of rental properties, further exacerbated by a drop in household size during the pandemic. House prices never saw a catastrophic drop in prices as some predicted, primarily because of housing shortages - many renters decided to become buyers and a shortage of new homes pushed more into the established home market.

It is therefore good news that construction costs are finally starting to ease. So much so that in Perth and Hobart, construction costs are actually declining. What has turned conditions around? 

There were a number of factors that have driven construction costs and lowered the number of homes built. Many of these are now being resolved, or will be over the next six months. 

Problems started with supply chain blockages. Shipping costs skyrocketed post-pandemic and the cost of building materials increased as a result. However, cost increases weren’t the only challenge. It also became slower to get building materials and this impacted productivity. It became slower to build as projects were delayed by a lack of materials. Supply chains are now moving smoothly again. 

The cost of materials also increased because we weren’t the only ones starting to build again post-pandemic. The cost of many raw materials skyrocketed as a result of increasing demand. 

Labour shortages have also been problematic and this is taking longer to fix. Higher migration is helping but that is also putting more pressure on housing demand. Competition from other building projects has also meant that demand for trades is coming from a wide range of sources.

Brisbane, where costs have skyrocketed the most, has felt this most significantly. Not only did Brisbane see high interstate migration through the pandemic requiring more homes, it has also been in the midst of a building boom - a new casino, new office buildings, infrastructure construction and rebuilding post floods. Labour costs are the reason why Brisbane saw the biggest jump in construction costs. 

Fewer building companies has also been a problem. As building costs skyrocketed, a large number of building companies became insolvent. Projects were again put on hold, or stopped mid construction. Like labour, it will take some time for this to improve again with less competition for building expected to keep prices more elevated.

Moderating construction costs are already leading to higher building approvals. Dwelling approvals are still very low but increased by seven per cent in August. Victoria is leading the way with an increase of 22 per cent. Renovations are also starting up again and the value of alterations and additions approved for homes is now getting close to where it was during the 2021 peak.

By Nerida Conisbee, Ray White Group Chief Economist.