Rebound in construction lending indicates improving conditions

The market for construction finance is gaining strength, with official data revealing an acceleration in lending, with falling construction costs also helping to support returns on construction lending. 

After many years of high building costs due to inflation, things are finally abating. This has led to a rise in new housing projects. According to the Australian Bureau of Statistics, loans for business construction grew by 7.9% in August 2024. This is 61.9% higher than the same time last year, showing strong growth. In July, loans had already increased by 5.4%, which shows that construction lending is bouncing back.

Separate June quarter Building Activity data from the ABS also highlights the total number of dwellings is recovering. Private sector house commencements rose 1.7% to 25,732 dwellings, following a rise of 5.7% in the March quarter. So, while industry operating conditions remain challenging for many residential developers, we are seeing some areas of resilience in construction, led by private sector housing.

Costs fall after building drop

Still, national dwelling approvals have held well below average in 2024, which has helped to dampen growth in construction costs. In the June quarter, the number of new homes being built in Australia dropped by 1.1%, down to 40,293 homes.

With the normalisation of construction costs, we expect to see greater level of construction activity and lending in 2025, to catch up with the huge demand for housing. This may help to alleviate the imbalance between new supply of housing and growth in demand. The improved outlook on costs will underpin greater demand for construction funding and potentially better returns on private construction credit.

Housing developers are now better positioned to deliver projects as construction costs align with typical market conditions after a blowout in costs during the pandemic. Pandemic-related supply chain disruptions and competition for resources from other types of construction pushed up prices significantly, by nearly 40% since late 2019, according to the central bank.

However, in recent times, construction costs have stabilised, 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 to build a typical new dwelling, rose just 2.6% during the 2023-24 financial year, the smallest annual rise in the national CCCI since March 2002 (2.3%), and significantly below the pre-COVID decade average of 4.0%.

The big gap

At the same time, housing demand in Australia has been running above housing supply for the past two decades causing a dwelling shortage. In 2024, it has been estimated that only 167,000 new homes will be completed, well below the demand of around 240,000 homes​. This gap has led to a national undersupply of approximately 200,000 dwellings.

With costs finally moderating, I’d expect to see more residential construction projects proceed as their feasibility improves. Such projects require substantial capital, often funded by corporate loans or private credit, which is where Vado Private plays an important role and we expect to see a greater demand for construction funding.

While unforeseen increases in construction materials, labour, or fees can lead to cost overruns, we are now seeing less risk of that. Investors can be more confident that development budgets are accurate and project costs will be controlled against ongoing strong demand for housing given the huge housing shortage. Vacancy rates too are near historical lows, which has seen a huge increase in demand for housing from investors.

The Australian Government has agreed to a National Housing Accord (Accord) with states and territories, local government, institutional investors and the construction sector. The Accord includes an initial aspirational target agreed by all parties to build one million new well‑located homes over 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 5 years from mid‑2024.

Vado Private has extensive experience in project and construction funding. Its track record includes the successful financing and delivery of residential and commercial developments across the eastern seaboard of Australia. Importantly, private credit funds have historically delivered attractive risk-adjusted returns; investors are seeing returns in the 8%-to-12% range across private credit.

While investors have been cautious towards construction projects, Vado Private only lends on the most secure of residential development projects, and understands the flow of funds throughout project lifecycles, including the availability of capital for completion and the need for developers to allocate funding for contingencies for unexpected delays.