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More misery for housebuilders

Created:

7 July 2009

Updated:

8 July 2009

Written by:

Claer Barrett

Judging by the cautiously optimistic tone of this week's round of trading statements from the housebuilders, the housing market is through the worst, and a gradual recovery is starting to take effect. All that's needed now, it seems, is for the mortgage lenders to ease the foot off the brakes a bit, and the housing market will be home and dry.

Unfortunately, such a scenario is as unlikely as a tastefully decorated showhome. Problems in the housebuilding sector are structural, rather than cyclical. The speed at which housebuilders down-sized during the current slump has been phenomenal - output has been slashed, headcount reduced, land transactions frozen and cash flow ploughed into paying down debt. What's more, cash flows have been propped up by selling stocks of homes, often at sizeable discounts, to enable them to renegotiate banking arrangements.

And there's a further problem lurking on the horizon. Soon, the housebuilders will have run out of homes to sell, and finding the cash to build more could test the established business model.

Pipeline running dry

The market has responded well to housebuilders' recovery strategies - since the start of this year, the sector has risen by 29 per cent, with semi-respectable sales figures and statistical props from house price indices proving fertiliser for the much-heralded 'green shoots'.

But sales have not been replaced with new stock. In the first five months of this year, Bovis sold 638 homes, but only physically built around 10 new ones. This may be the most extreme example, but neatly illustrates the point that housebuilders have, essentially, all sold their way through most of their standing stock.

"The industry has persuaded itself that the scarcity value created by there being no stock will mean that people will buy off-plan again, but this is a pipe dream," argues Robin Hardy, housing analyst at KBC Peel Hunt.

He also believes that selling from more mature sites has added an unsustainable level of optimism to current sales figures. "If you think about it, it's a much more favourable environment for selling. It feels like a lived-in community, you can actually see what you're getting. Compare that to trying to persuade someone in a muddy field on a cold November afternoon that this plot is going to be their dream home in a few years."

So, while this week's trading statements had a lot to say about how good things had been, sector analysts aren't convinced that there's room for much more improvement yet. They concur that at some point, the housebuilders will have to re-engage with the market and think about raising equity to fund the next round of development.

Death by a thousand cuts

But there are many factors in play that will shape their future developments. The constrained mortgage market is the biggest single barrier to growth. Much has been made of any survey or statistic showing any kind of growth, regardless of how small a base it comes from - and most of those bases have been very small indeed.

But the fact remains - lenders are commonly insisting on a 25 per cent deposit on homes built in the last two years, far beyond the means of many would-be buyers. Shared equity incentives, not to mention the trusty 'bank of Mum and Dad' route, have alleviated some of the pain. But economic think-tank Capital Economics points out that it's not just the withdrawal of high loan-to-value mortgages that has stymied the market.

"Contrary to popular perceptions, FSA [Financial Services Authority] data indicates that the reduction in loan-to-income ratios has had a bigger negative impact on lending than the reduction in loan-to-value ratios," argues Seema Shah, property economist, estimating this accounts for up to 60 per cent of the decline in approvals. "In an environment where inflation fears are rising and where the only way for interest rates is up, we doubt that loans equivalent to four, five or six times salary will reappear."

Lenders have reserved their best rates for borrowers with deposits of 30 per cent or more looking to borrow less than 2.5 times their salary, meaning a lot of housing stock is simply out of most buyers' reach at current prices. To unfreeze the market, mortgage lenders will have to relax their lending criteria or, as is far more likely, house prices will need to fall further still to bring them into line with real incomes.

Former Redrow chief executive Paul Pedley is among those waiting for house prices to fall even further. This week, he announced his intention to float a £50m company targeted at acquiring distressed new-build property, London Residential Opportunities, for eventual resale into a better market.

"People need homes - and the reasons haven't gone away," he argues. "What took years in the 1990s we've seen happen inside 18 months; transactions are down 60 per cent, house prices have fallen 20 per cent or more, the land market has dried up and work in progress has been cut back. All this means number of homes built this year is predicted to be 60,000 compared to 180,000 delivered in 2007."

It is also woefully short of the (now long forgotten) government target of delivering 240,000 new homes a year. Additionally, the growing need for social and affordable homes gives the industry a political platform to build on. But while the housebuilders can come up with many good reasons for dusting off their trowels, finding the cash is the big issue.

Raising the roof

With the banks wary of increasing lending exposure - to companies as well as buyers - tapping the market is the obvious solution. But analysts suggest that unless builders have a proposal sitting in institutional in-trays already, it may be too late. "The problem is the housebuilders share exactly the same strategy," adds Mr Hardy. "They can't all raise money to do the same thing at the same time, namely buy cheap land and start to rebuild their margins."

That said, it would be beneficial for the likes of Bovis - as it is debt free, institutions and private investors could be sure that proceeds from a placing or rights issue would be targeted on investment. Compare this to Barratt or Taylor Wimpey, who still have leaky balance sheets to repair, meaning any equity finance could be diverted away from much-needed new opportunities.

The form new opportunities might take is also subject to debate. The housebuilders have shown they can adapt well to the challenges of providing social housing, and companies could balance their businesses going forward by developing more for the public sector.

"The sales margins would be lower, but the cash flow and cash generation on these projects is infinitely better," says Mark Hughes, real estate analyst at Panmure Gordon. "The margin as return on invested capital would actually be better because of the way these projects are funded, with monies received in bulk up-front."

The urge to diversify also stretches into product mix. Property company St Modwen surprised the market this week, when it revealed housebuilders are back in the land market buying its brownfield sites. "We have done one deal, and expect to seal three or four more by our year-end at or around book value," says chief executive Bill Oliver.

Interestingly, Mr Oliver says the sites in question are all "lower density family-type housing, not flats. That's obviously where the builders' see demand in the market at the moment."

"Quoted and private builders are in the market. What they've all got in common is they're all after deferred payment terms. Our sites all have outline planning permission for housing, and they pay the bulk of the consideration when they get the detailed consent, which minimises their cash outlay."

Having rebuilt their balance sheets, rebuilding their organisations will be another challenge for the builders. The scale of job losses in the industry has been swift and savage, and the extent of the wind down will haunt the sector for years to come.

"The industry took years to recover from the last downturn," remembers Mr Pedley. "It is very hard to grow housing output at more than 5 per cent a year, as it takes time to re-open subsidiaries, re-invest in land, and rebuild relationships with sub-contractors. The biggest challenge ahead for the housebuilders is going through this process." It remains to be seen whether they cave in under the weight of market pressures.