After high levels of activity over the past three years, there was an expectation – before COVID-19 hit – that the non-residential construction cycle would peak in 2020 and slow from there. However, as with the residential sector, COVID-19 and the deep recession will have lasting impact on the non-residential construction cycle. While the $50 billion worth of projects already underway will get completed, the pipeline is expected to weaken substantially.
Getting a lot of press is the rigorous debate about demand for office space as the great ‘work from home’ experiment put the trend on warp speed. Indeed, an ABS survey taken in June showed over a third of all Australians worked from home in the month. In a survey a month later, 25 per cent of Australians reported they would like to work or study more from home going forward. This is particularly relevant in Sydney and Melbourne, which are not only Australia’s largest cities but have already seen a rise in office supply and still have a number of large projects getting closer to completion. While the debate about how much office space businesses will demand rages, one thing is clear, the office will need to look different and demand at least somewhat lower. Interestingly, there is little discussion about the increased demand for warehousing and logistics as COVID-19 has also accelerated online shopping, for example.
Perhaps most striking for this segment is that given non-residential investment tends to focus on large, expensive projects, extreme uncertainty is outweighing cheap and available credit. Or in other words, the hurdle rate on which projects are assessed may have risen as the risk premia shot up and business interest rates only edged lower. In short, there is little appetite for increased debt in an uncertain world.
Can the public sector fill the gap?
The public sector is always active with construction, building the needs of a nation. However, it is also a very effective counter-cycle tool, to support economic activity and jobs when times are tough but also boosting the capital stock and drives productivity gains. A 2009 report by the Organisation for Economic Co-operation and Development (OECD) estimated that an increase in public investment of $1 billion boosts GDP by around $1.1–$1.3 billion after two years. The use of public – private partnerships and sub-contractors means that public spending also has spill over benefits to the private sector. There is a catch, though. It is the change in the level of activity that generates economic growth, and the pipeline of public investment is already high. In fact, the large number of projects has led to certain parts of the country experiencing a shortage of specialist resources and to cost and time overruns on some major projects.
The amount of public sector work underway and yet to be completed prior to COVID-19 was already substantial – work yet to be done rose to $42 billion in the March quarter 2020, equivalent to 29 per cent of total work yet to be done – and there are already reports of capacity constraints on specific projects. In June, public sector investment rose by 1.0 per cent to be 1.8 per cent higher through the year. However, these projects have even longer lead times than non-residential construction, running into decades in some cases. Importantly, analysis of the General Government budgets (who are mostly responsible for this type of spending) shows that the peak infrastructure spend occurred in 2019-20. While the level of activity is set to remain high, counter-cyclical support for the economy will require a lift in the pipeline. To get spending above 2019-20 levels for 2020-21 and 2021-22 would require additional $8.5 billion of spending over two years, and even more if the aim is to offset the slowdown in the private sector.