From boom to bust: the self-perpetuating cycle of NZ’s residential building industry

From boom to bust: the self-perpetuating cycle of NZ’s residential building industry

An abundance of small building firms helps drive the boom to bust cycle in New Zealand’s residential building industry, says Westpac Industry economist Paul Clark.

In his Industry Insight report, Paul says the country has a large number of very small firms who enter and exit the industry in response to changes in demand.

“All of these firms operate in an environment of extremely variable demand and as a result, residential building activity is far more volatile than the economy in general.  A number of factors shape demand for residential building activity,” says Paul.  

“Some of these are of a structural nature and support demand over the long-term.  Natural increases in population size and changes in age profile fit neatly within this category.  This is why we’ve seen an increase in number of firms entering the industry since 2010.

“Others factors, such as movements in interest rates and changing net migration patterns, tend to be more cyclical and have short-term impacts on demand.  These can be really significant.

“Then there are disruptive factors,” he adds.  “These have large impacts on demand but typically only a specified period of time.  A good example would be the increase in demand for building work that followed the 2011 earthquake in Canterbury. “

“As a consequence of the boom and bust cycles, smaller firms tend to be short-term focussed and reluctant to invest in people or plant and machinery even in the boom times, relying on contractors and other service providers to fill the gap,” says Paul.

“This discourages real industry innovation and limits productivity gains needed to improve industry competitiveness and reduce building costs. The boom bust cycle repeats.”

Of the 18,500 firms that make up the residential building industry today, 86 per cent have five or fewer employees, a further eight per cent have between six and nine people working for them. These companies tend to operate in localised markets building standalone houses, one at a time, up to two to three a year.

Another five per cent of firms have been 10 and 19 employees and complete more houses per year. An additional one per cent of firms have been 20 and 49 employees, and remaining firms employ more than 50 people.

The residential building industry contributed about $3.6 billion to the NZ economy in 2016 so it’s an important contributor to GDP.

Paul says over time, competitive forces will result in larger firms dominating the building of houses. This is because they can generate the economies of scale necessary for improving operating efficiencies which help to lower costs.  Smaller players just cannot generate the same economies of scale. . This does not mean that small players will disappear from home building, but over time, we think that they will increasingly be confined to the margins,” Paul says.

“Larger firms can withstand boom to bust cycles if they’re able to improve operating efficiencies.   That means investing in new work organisation methods and developing and/or adopting new products, including off-site prefabrication which dramatically cuts the time for building homes, and also greater use of 3-D printing. All of this should lead to productivity gains,” he says. 

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