This article first appeared in Mitre 10 Trade Quarterly – Winter 2018.
One of the comments I often hear talking to people in the residential construction industry is that alterations and new building activity move in different directions. The comment is usually made in the context of a drop-off in new building, when alterations and additions (A&A) are viewed as a cushion to soften the downturn. But the data does not back up this assertion.
Graph 1 shows the ups and downs of residential building over the last decade, split into new work and alterations activity. Data limitations mean that the graph only covers consented building activity. However, American data suggests that at least as much money again goes into non-consented renovations such as redecorating or new kitchens, and that this spending shows the same cyclical pattern as consented work.
A quick glance confirms that new building and alterations activity move in tandem. That’s not to say that getting involved in a mix of the two building types is a bad business move. Although the two subsections of residential construction move together, our graph also shows that new building activity is, in general, more variable throughout the cycle than A&A work. In other words, A&A activity falls by less during a downturn, and so helps mitigate the squeeze caused by the decline in new residential building.
What are the main drivers of A&A activity?
Work we have previously done indicates three key influences.
The first driver is house sales. When people buy or sell a property, renovation work often takes place around the time of the transaction. For the seller, this work is more likely to be non-consented activity to make the property more saleable – new carpet or a lick of paint, for example. Although some buyers will also do cosmetic renovation work, they are probably more likely than sellers to undertake more structural alterations and additions to make sure the new property best meets their needs.
Not all renovation work is tied up with a house sale. The second key influence on A&A activity is interest rates. Lower mortgage rates directly stimulate the housing market, but they also free up money in household budgets, as well as making it “cheaper” to borrow for renovations. Our analysis suggests that it takes about a year for the effects of mortgage rate changes to flow through into A&A work.
The other cyclical driver of A&A work is household incomes. Increases in real incomes (that is, over and above CPI inflation) give households more spending power. Some of that increased discretionary spend ends up going on renovations.
Graph 2 shows our forecast for A&A work over the next few years. We predict an 11% drop in activity during 2018 as the softer housing market reduces the amount of renovation work taking place. As the tail end of quake repair work in Christchurch is finished over the next few quarters, it will also dampen total activity. Nevertheless, we still expect overall spending on A&A work to hold close to the previous record reached in the middle of last decade, reflecting broader economic conditions that will stay relatively positive for renovation work.
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