Construction loan recovery signals improving conditions – Simon Arraj

The construction finance market is gaining strength, with official data pointing to an acceleration in lending, with falling construction costs also supporting returns on construction loans.

After many years of high construction costs due to inflation, business is finally slowing down. This has led to an increase in new housing projects. According to the Australian Bureau of Statistics, commercial construction loans grew 7.9% in August 2024. This is 61.9% higher than the same period last year, indicating strong growth. By July, loans had already increased by 5.4%, showing that construction loans are recovering.

Separate June quarter construction activity data from the ABS also shows the overall number of homes is recovering. The number of private sector homes rose 1.7% to 25,732 homes, following a 5.7% increase in the March quarter. While business conditions in the sector remain challenging for many residential developers, we are seeing some areas of resilience in the construction sector, led by private sector residential construction.

Costs drop after the building falls

Still, national housing permits remained well below average through 2024, which has helped dampen construction cost growth. In the June quarter, the number of new homes built in Australia fell 1.1% to 40,293 homes.

With the normalization of construction costs, we expect a higher level of construction activity and lending in 2025 to catch up with the huge demand for housing. This can help alleviate the imbalance between new housing supply and demand growth. The improved cost outlook will support greater demand for construction financing and potentially better returns on private construction loans.

Residential developers are now better positioned to deliver projects as construction costs align with typical market conditions following a huge cost increase during the pandemic. According to the central bank, pandemic-related supply chain disruptions and competition for raw materials from other types of construction have pushed prices up significantly, by almost 40% since the end of 2019.

Recently, however, construction costs have stabilized and are growing at the slowest annual rate in 22 years, according to CoreLogic’s Cordell Construction Cost Index (CCCI). The national index, which tracks the cost of building a typical new home, rose just 2.6% in the 2023-2024 financial year, the smallest annual increase in the national CCCI since March 2002 (2.3%). and significantly lower than pre-COVID-19 levels. decade average of 4.0%.

The great divide

At the same time, demand for housing in Australia has exceeded housing supply over the past twenty years, creating a housing shortage. It is estimated that only 167,000 new homes will be completed in 2024, well below the demand of approximately 240,000 homes. This gap has led to a national undersupply of approximately 200,000 homes.

With costs finally coming down, I expect more housing projects to move forward as their feasibility improves. Such projects require substantial capital, often financed by corporate loans or private credit, and that is where Vado Private plays an important role and we expect to see increased demand for construction financing.

Although unforeseen increases in construction materials, labor or fees can lead to cost overruns, we now see less risk of this. Investors can have greater confidence that development budgets are accurate and that project costs will be kept under control in light of continued strong housing demand given the massive housing shortage. The vacancy rate is also almost at a historic low, which has increased the demand for housing from investors enormously.

The Australian Government has entered into a National Housing Agreement (Accord) with states and territories, local governments, institutional investors and the construction industry. The Agreement includes an initial ambitious goal agreed by all parties to build one million new, well-located homes over a period of five years from mid-2024. The Commonwealth agreed to update this target at National Cabinet in August 2023 to 1.2 million new, well-located homes over five years from mid-2024.

Vado Private has extensive experience with project and construction financing. Its track record includes the successful financing and delivery of residential and commercial developments on the east coast of Australia. Importantly, private credit funds have historically delivered attractive risk-adjusted returns; investors see returns in the range of 8% to 12% for private credit.

While investors have been cautious about construction projects, Vado Private only lends on the safest residential development projects and understands the flow of funds over the life cycle of projects, including the availability of capital for completion and the need for developers to allocate financing for contingencies . unexpected delays.