Australia is suffering a housing affordability crisis. Since 2019, the average price of a residential dwelling has risen by 38%, capital city rents have increased by 15%. As interest rates increased, households’ debt servicing costs have risen from around 4.0% to 7.5% of disposable income.

Demand for housing is clearly outstripping supply. So urgent is the issue that the Commonwealth and state governments have agreed a National Housing Accord, which targets the building of 1.2 million new homes over the next five years. If met, this will expand the national housing stock by approximately 10%.

While these efforts to increase housing supply is very welcome, they pose an important question: is the Australian construction industry ready to supply these 1.2 million new homes?

With robust demand, rapidly rising prices, and government stepping on the supply accelerator, you might expect the home building industry to be in rude health. Yet we find precisely the opposite. Housing completions have declined, builders’ profitability has fallen, and the number of construction insolvencies has nearly tripled in the last two years.

How can the home building industry be performing so poorly at a time when demand for houses has never been higher? This research notes digs into the data to perform a health check on this critical national industry.

It finds that while the construction industry as a whole is growing solidly, the residential building sector has not. Operating margins have fallen in the face of rising costs that haven’t been fully passed onto consumers, making building the least commercially viable branch of construction. Workforce shortages and excess vacancies have further weakened an already fragile sector.

Unless something is done to return the building industry to health, Australia will struggle to meet its aspirations to build the houses we desperately need.

While construction is growing, home building is not

Contrary to popular belief, Australia’s construction industry is growing in overall terms. The sector completed $258 billion worth of work in 2023, in real terms the highest figure on record.

Construction work done increased by 8.3% in the year, a very solid performance when compared to Australia’s paltry 1.5% rate of GDP growth.

But while construction is growing, home building is not. Only $81 billion of the work completed in 2023 was residential buildings, just under a third of the total. As the chart below shows, residential building rates fell by 10% during the interruptions of the pandemic, and have not recovered in the two years since.

Shockingly, Australia completed the same amount of new housing work in 2023 as we did in 2020 – a year that was marred by repeated lockdowns and supply chain chaos.

All of the recent growth in the construction industry is due to the engineering sector – the building of transport, energy, and industrial and other infrastructure. Engineering work rates have boomed since the pandemic, and now accounts for around half of national construction activity. This boom is heavily driven state government infrastructure programs, particularly road and energy building.

But why, in the midst of a property boom and housing affordability crisis, are housing build rates failing to lift up to meet massive demand? The problem is clearly unique to house building, as other branches of construction are managing to raise their output.

A tale of two construction industries

A look at financial performance within the construction industry provides our answer – it has become far less commercially viable to build housing in Australia.

The chart below estimates business operating margins for the three main branches of construction: building, engineering and construction services. Overall constructor margins were 9.3% in 2022-23 – slightly down as a result recent inflationary pressures, though not far off their long-term average of 9.9%.

But when we examine operating margins by subindustry, the problems afflicting house building become clear.

Builder margins have collapsed following the pandemic – from a normal rate around 8%, to only 5.6% in 2022-23. At the same time, those enjoyed by the civil engineering sector have surged from 4.2% to 5.5%. Construction services, which supplies into both, has maintained steady and healthy margins around 14%.

The has also been a problematic inversion between building and engineering margins. Building projects typically faces less commercial risk than engineering works, and so historically have had higher operating margins to compensate constructors for taking on higher risk. But since the pandemic that pattern has ended, with builders no longer enjoying a premium.

In other words, house building has become the least commercially attractive branch of construction. As investment decisions balance risk and return, and returns are roughly equal, all the post-pandemic growth in construction has flowed into low-risk engineering projects instead.

Home builders can’t pass on surging costs like civil engineering can

The reason that margins are collapsing for builders but not engineering constructors is due to subindustry differences how costs can be passed onto customers.

As the charts below show, costs have risen dramatically for both branches of the industry. Since 2017-18, builders’ material costs have risen by 29% and wages by 42%. Engineering has faced the same but worse, with wages up 31% and materials a whopping 64%.

But while cost pressures are a universal, the ability to pass on these costs is not.

Builders’ sales income has only grown 22% over the same period, well below the increases faces for wages or materials. Unable to raise income sufficiently to pass on rising costs, builder operating profits have fallen by 17%.

Engineering constructors have no such problems. Sales income has grown by 48% - roughly midway between materials and wages – indicating that rising costs are largely being passed on to customers. With costs passed on and work surging, engineering operating profits have boomed, and have grown 140% on their 2017-18 level.

This dynamic is due to differences in contracting structures between building and engineering construction. Building projects are more likely to feature fixed price contracts, which leave the builder responsible for any cost blowouts arising from inflation or delays. Such arrangements are rare in infrastructure works, particularly those for the public sector, where contracts enable many cost overruns to be passed onto the consumer.

The consequence of these contracting differences is that building firms are often left carrying the can for rising costs, and have seen their profitability fall as a result. If lower risk work is available on infrastructure projects, who would build houses?

Workforce shortages plague an already fragile industry

Beyond the problem of cost and margin pressures, the industry is also struggling to secure sufficient labour, adding further pressure to builders.

The construction industry uses a high proportion of trades skills, which are presently in exceedingly short supply. According to Jobs and Skills Australia research, every occupation in the construction trades field was classified as facing a national shortage in 2023. This makes construction the most skill-shortage afflicted industry in Australia.

This has led to a dramatic overhang of vacant jobs. In the first quarter of 2024 there were 27,500 vacant construction jobs in Australia, equivalent to 2.2% of all industry jobs. This is close to double the normal rate of vacancies. The vacancy rate was a high as 3.1% in mid-2022, but has since come down with the easing labour market.

There is also a distinct geographic pattern to construction vacancies. Rates are much higher than the national average outside of NSW and Victoria, where the construction industry often faces competition for trades skills with the mining sector. As Queensland and WA have some of the fastest growing populations, their more pronounced vacancies problems augur poorly for growth in house building in the places it is most needed.

Skills shortages and excess vacancies have meant the industry has struggled to expand its workforce to meet growing demand. The building industry employed 363,400 people in November 2023, barely more than the 350,700 it employed three years earlier in November 2020. Unable to meaningfully expand the workforce, it should be no surprise that builders have struggled to raise completions.

Without a stronger building industry, we won’t meet our housing needs

The implications of this crisis facing the building industry go far beyond those for businesses and employees in the sector. Without a fairly immediate change in business conditions for home builders, there is no prospect for Australia to meet its new housing needs.

In 2023, the Commonwealth and state governments agreed a National Housing Accord. Its centrepiece was a target to build 1.2 million new well-located homes over five years from mid-2024. With the governments committed to directly building only 20,000 affordable homes, the private sector is expected to deliver the other 98.2% on its own.

The target implies that 60,000 new dwellings are on average completed each quarter. And we are on long way from being on track to reach this number.

The Australian building industry has never turned out this many new homes before – the best figure was 57,800 in the December quarter of 2016. And worryingly, the run rate is falling. We completed an average of 45,500 new homes per quarter in 2020 – a year marred by COVID interruptions – yet only 43,200 last year.

Equally concerning is performance in residential units, which are especially important for in-fill developments that raise density and ensure homes are “well-located”. Only a third of last year’s housing completions were residential units, and the rate is falling. At a peak in 2017 Australia was completing an average of 24,800 units per quarter, but in 2023 this had fallen to only 14,400.

The private sector will need to immediately improve its home build rates by around 40% if we have any chance of meeting the National Housing Accord target.

And if we need the private sector to step on the home building gas, we need to ensure commercially viable businesses. The construction industry as a whole is relatively healthy, as government infrastructure spending has propped up the engineering sector. But house builders have been left out in the cold, while margins have been squeezed by rising costs and profits have fallen.

This is clearly not a sustainable outcome. The challenges facing the home building industry must be addressed if Australia has any hope of addressing our chronic housing shortages. 

Dr Jeffrey Wilson

Dr Jeffrey Wilson is Ai Group's Director of Research and Economics. He leads our economics team, and provides strategic direction in developing the research program to support our advocacy, service delivery and policy activities. He specialises in international economic policy, with a focus on how trade and investment shape the Australian business environment.