BNZ chief economist Mike Jones, in his latest Eco-Pulse, says that’s big, but not miles out of line with global trends.

“Construction has been a declining part of many of New Zealand’s trading partner’s economies. The share of NZ’s GDP devoted to home building nevertheless remains much higher than most.”

He says residential construction is one sector in the ‘interest rate sensitive’ set being talked about a little more now that rates are on the way down, but challenges from elevated build costs, falling house prices, and an easing population tailwind are keeping residential building at low levels.

One of the sector’s biggest challenges has been an explosion in costs.

Construction cost inflation soared 35-40 per cent from 2020 to 2023. It’s since flattened off, but the overall level of costs is still elevated, Jones says.

The average build cost of a stand-alone house, implied from consents, has held at about $3300/m2. That’s about $1000/m2 more than in 2020. And he adds: “These estimates are likely to be understated.”

Adding in the average cost of a section to these figures produces an average build cost estimate that is still well north of the median cost of an existing home.

“The analysis is indicative, but it lines up with the anecdote: it’s still generally cheaper to buy existing than to build new,” Jones says.

This historically wide differential has dampened the financial incentive to build. “Indeed, the current house price/build cost combination is consistent with small declines in building activity. History suggests that a turn in the construction cycle is usually, but not always, preceded by a lift in this ratio.”

Consents still in the doldrums
Keeping an eye on building consents for a steer on future building activity, Jones says while the pace of monthly consents is still running about a third below the 2022 highs, more encouragingly, consent issuance has stabilised this year.

This has been led by a lift in consents for stand-alone houses, with consents for townhouses and apartments still on the back foot. Amongst the regions, Otago, Canterbury and Waikato have shown the most obvious signs of life.

“Stabilisation or not, the low level of consenting – not to mention the usual lags to getting a spade in the ground – suggest the downturn in residential building activity has got a little further to run,” he says.

Population tailwinds
The tailwind from buoyant housing demand has also eased.

The rate of house construction undershot estimated population requirements through last year as migration boomed. Jones says the rapid cooling in population growth means changes in housing demand and supply are now less out of whack.

An indicator of pressure on the housing stock (the number of people per dwelling PPD) rose over 2023 but may have already peaked at a lower level than might have been expected at 2.6.

“That’s after PPD fell aggressively over 2021 and 2022 as home building activity caught up with prior growth in the population.”

Declining interest rates
Despite all these headwinds, Jones says a couple of key macro factors are starting to move in a more supportive direction for residential construction.

Interest rates are in decline and house prices are expected to rise a little next year.

“In time we expect these factors to help drive a turn in the residential construction cycle. We’ve pencilled the beginnings of this in for early next year. Picking investment cycles is still a tall order, though and our sense is that there’s risk of delay.”

He says when the sector does find its feet it will have an important steadying influence on some of the other beaten-up sectors of the economy that have links to construction. Areas, such as manufacturing and (durables) spending.

“The sector itself appears to be feeling less downbeat. Surveyed construction intentions have perked up noticeably.”

Jones says if that’s sustained, it should help solidify the stabilisation underway in consenting activity.