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Housebuilders set fair for another year

Demand for new homes and moderation in house price inflation and building costs suggest that housebuilders are set fair for another year
December 18, 2015

Without exception UK housebuilders' profits, operating margins and return on equity all continued to grow in 2015. The share price performance varied considerably, though; Bovis Homes (BVS) ended the year much where it started, while Taylor Wimpey (TW.) shares rose more than 40 per cent.

However, one constant was a significant fall from the highs touched earlier in the year. Having recovered after an uncertain start caused by the UK general election, prices were hit later in the year by a combination of interest rate concerns and high valuations. There was, in fact, a number of what-ifs that seemed to hold sway. As well as the interest rate question, there was increased concern about rising build cost inflation and inflation in house prices themselves.

Looking ahead to the new year, we're inclined to put these to one side, believing that the supply/demand imbalance will continue to underpin prices, as evidenced by the record forward order books that many housebuilders are sporting.

Why do we place less importance on the 'if' factors? Here's why. Interest rates are going to rise at some point, with the US Fed largely in the driving seat, although UK inflation is going to have to accelerate (from nothing) quite quickly to make a hike in UK rates more credible. And, while of some psychological significance, pushing rates up from 0.5 per cent to 0.75 per cent will hardly make any difference, especially as many mortgages are on fixed rates.

The second worry, that of rising build costs, can be dismissed in two ways. The sector has worked hard to replace the 300,000 skilled workers who left after the financial crash, and this is starting to pay results through apprenticeship schemes and overseas workers. However, there remains a big shortage of skilled labour. Raw material costs have risen, but are expected to moderate as suppliers, such as brick makers, increase production.

 

 

House price inflation is an important factor, but we have to remember that new house prices follow the trend in the secondary market. Towards the end of this year, the number of properties coming on to the market tended to fall, thus driving prices higher. But this trend is finite. Putting it simply; house price inflation can only be sustained to the extent that buyers can afford the prices. And this is the way forward that is different from the run-up to the last peak. At that time, house price inflation was easily accommodated by banks lending more and more money; this time the mortgage market is much more strictly controlled, and house prices will not accelerate beyond what potential buyers can sensibly afford.

Every housebuilder would like to see cost inflation moderating (it is); house price inflation moderating (it is); land price inflation remaining benign (it is); which leaves us to suggest that the current gravy train still has some way to run. At some point, however, housebuilders will moderate the pace of replacement in their land banks; it's tempting not to, given the relatively affordable prices. If this happens, there will be even more cash being thrown off the business model, and already the likes of Persimmon (PSN) and Berkeley Group (BKG) have generous dividend packages in place for the next five years.

Following the chancellor's Autumn statement, which contained an array of initiatives to stimulate increased output, the picture has become a little muddied. Raising funds through higher stamp duty on second home purchases to pay for increased output seems workable, even if there are some unintended consequences for the rental sector. However, the one key restraint that has barely been mentioned is the shortage of skilled workers. These are already in short supply, and to increase output significantly in the short term is simply not possible.

How will all this affect the publicly quoted housebuilders? In the short term there will be no effect at all. Loosening up brownfield sites and steering the process through planning departments will take time and, as yet, there is no mechanism in place to facilitate putting all this new-found money into the pockets of the builders.

All housebuilders want to do is build and sell houses in a measured fashion, with no double-digit price inflation - itself unsustainable - moderate build-cost inflation and a benign land environment. At the moment, this looks to be a reasonable scenario for the coming months. And by adhering to internal hurdles on capital returns, and by increasing the number of sales outlets, next year looks to be another period of steady but solid progress.