New data from Stats NZ shows that the residential construction subindustry might be over the worst of its cost pressures. Residential construction costs rose by 2.0% in the December 2022 quarter and, although cost inflation is still highly elevated compared to the last three decades, this quarterly increase was the smallest since March 2021. Chart 1 shows that annual cost inflation for dwelling units has now eased from 16% to 13%pa since mid-2022.

The news is perhaps not quite so good in the other construction subindustries. Non-residential construction costs rose by 1.8%pa in the December quarter, which was a larger rise than the previous quarter. Nevertheless, annual cost growth has edged down from 11% to 10%pa since June 2022.

Civil construction costs rose 3.2% in the December quarter, which was also an acceleration from September’s 2.6% increase. The pick-up was underpinned by a 6.0% jump in costs for transport ways, which was the largest quarterly rise since 1981. Annual civil construction cost inflation is now at 15%pa, and we estimate this is the fastest rate of increase in 40 years.

We have typically seen in previous construction cycles that trends in cost growth for non-residential and civil construction lag trends in residential construction costs by about six months. This difference is likely to be because of longer lead times in larger non-residential and civil projects, meaning that changes in materials or labour costs take longer to be factored into pricing than for residential projects.

The current trends also reflect that residential activity has been at extremely elevated levels for some time, whereas capacity pressures in the non-residential subindustry have been less stretched, and the pick-up in infrastructure activity has been more recent. Notwithstanding the pipeline of residential consents awaiting completion, the looming downturn in residential construction is likely to mean residential cost inflation also eases more quickly than cost growth for either of the other two construction subindustries.

Stats NZ has made structural changes to the Capital Goods Price Index, which contains the indices that we have previously used to deflate building consents and work put in place to obtain estimates of the real (inflation-adjusted) volume of activity. The most significant of these changes, as they relate to construction, are as follows.

• Residential buildings previously included hostels and boarding houses. Hostels and boarding houses have been moved into a new category entitled “hotels, motels, boarding houses, and prisons”. This index now, more logically, comes under non-residential buildings.
• The old dwellings and out-buildings index has been split into two new indices within residential buildings: dwelling units; and domestic outbuildings.
• Within non-residential buildings, the “other non-residential buildings” index has been split into two new indices: hospitals, nursing homes, and other health buildings; and educational buildings.
• There have been several changes to the coverage within the civil construction subindices, as well as the creation of a new subindex for construction of telecommunications infrastructure.

These changes have not made any differences to the historical data for non-residential or civil construction. For residential construction, the total residential buildings index now corresponds most closely to the dwellings and out-buildings index that we used to deflate residential consents and work put in place. For data from 1989 onwards, we will use this new index to calculate our measures of real residential consent values and work put in place. As a result, clients should note that there will be small changes to our historical estimates of residential activity when we publish our next forecasts on 14 April.

Our forecasts published last month predicted that building cost inflation would ease to about 4.5%pa by the end of this year for non-residential and civil construction, and to 7.3%pa for residential construction. Following the devastation caused by Cyclone Gabrielle last month, those expectations of slowing building cost inflation might need to be reassessed.

In the wake of the 2011 Christchurch earthquake, residential construction costs in Canterbury1 jumped 3.2% in the June 2011 quarter, compared to a more normal 0.6% increase around the rest of the country. Then, after a small breather in the September 2011 quarter, residential construction cost inflation in Canterbury over the next three years totalled 28%, compared to just 10% around the rest of the country. Chart 2 shows that the gap was greatest between March 2012 and June 2013, with Canterbury’s cost inflation peaking at 12%pa in the year to March 2013 while the rest of the country’s costs rose by just 1.9%pa. If we assume that there were no spill-over effects into larger-than-usual cost increases in other regions, demand pressures in Canterbury added about 1.4 percentage points to nationwide residential construction cost inflation in the March 2013 year.2

We are still assessing the effects of Cyclone Gabrielle and the magnitude of repair and rebuilding work that will be required in coming years. However, at this stage, it seems fair to assume that the most affected regions, Hawke’s Bay and Gisborne, will experience significant construction cost pressures over the next couple of years. These pressures are likely to be felt most intensely in the residential and infrastructure subindustries.

At a nationwide level, the construction industry also faces the challenge of its capacity already being stretched by high levels of activity. Cost inflation is arguably more embedded in the economy than at any time since the early 1990s, and additional demand pressures associated with the post-cyclone recovery could easily add to the momentum in costs and lead to inflation being sustained at faster rates for longer.

Furthermore, high levels of activity at a nationwide level also mean there is possibly less scope to divert resources from other regions to meet the expected lift in demand in the cyclone-affected areas. The only signs of potential capacity relief are for residential building, where monthly consent numbers have eased about 19% from their peak in March last year and are set to continue declining throughout 2023 and 2024.

We will update our outlook for construction cost inflation when our next set of building forecasts are published on 14 April.

1 As measured by the “purchase of housing” index within the Consumers Price Index.

2 It’s also worthwhile noting that most of the higher-than-usual cost increases in Canterbury during the post-quake rebuild reversed out in later years. Over the decade to March 2021, residential construction costs rose 54% in Canterbury, compared to 52% around the rest of New Zealand.