Residential construction is facing a major downturn

By Joe Montero

BIS Oxford Economics has just joined the list of those who are predicting the end of the building bubble, suggesting that it will become more pronounced over the next 12 months.

The forecasting company says that the number of new constructions will decrease from a peak of above 230,000, to a trough of around 160,000 in three years, which is a slump of 312 percent.

However, in the inner city ‘apartment’ sectors of Australia’s major population centres, the fall is likely to be more dramatic.

The underlying reason why there is an expected fall is that speculative investment has led to an excessive construction and prices that are well above the capacity of a large part of Australia. The building of dwellings had been significantly government subsidized, guaranteeing larger profits for investors and at the same time, artificially creating the oversupply, while guaranteeing continuing high prices.

This could never be sustainable in the longer run.

Aggravating the weakness inherent in the industry is the worsening performance of the Australian economy. Declining full time and permanent employment, the falling wages share of national income, exacerbated by the move to slash penalty rates and other existing entitlements, must translate into fewer being able to take out a mortgage for a new home and it is expected that the rate of mortgage defaults will rise accordingly.

A decline in construction jobs will contribute to the number of Australians finding themselves unemployed.

The political climate will increasingly pressure government into imposing limits on foreign based buyers to acquire properties in Australia. This will also have a significant impact.

Available data shows that over recent decades, the short-term peaks and troughs have been getting causes to long-term structural weakness, which can be seen in the relationship between a weakening economy overall and the corresponding rise of the real estate bubble.

Manufacturing and other traditional industries have experienced a major decline in their rate of profit and have subsequently been dying. Investment has been pulled away and the holders of this capital have had an incentive to find new sources of profit.

The greatest part of the new investment has been channeled into the financial industry. A characteristic of finance is that it is very fluid. This means that it is inherently more unstable, because it can be put to another use in a very short time.

Fluidity makes the finance industry suitable for speculative activity and the bigger it is in proportion to the overall economy, the more the economy its consequences will be spread over the whole economy. The real estate bubble is of these. It can rise to great heights, but is also capable of falling to great depths.

This sort if investment creates profit for some. The price is that in addition to pulling funds away from other uses, ongoing commercial transactions that are not tied to the real economy and create new value, work as a means of creating money unconnected with the supply trend and therefore pull up prices.

Although the construction industry does create value in the form of new buildings, there is also that significant element in the real estate industry that is not driven by this, but by speculative rewards.

Effective government subsidies through negative gearing and other allowances and subsidies may contribute to the problem, they are not its fundamental cause. These certainly need to be pulled back over time.

Most important is that action is needed to channel funds from the bloated financial industry into areas that will build the real economy, which will have flow through effects that include the reaction of real jobs, raise incomes across the board and counter the harmful long-term impact of the over speculative economy.

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