There were a number of developments last year that could have derailed the renaissance being enjoyed by the major housebuilders. One overriding factor kept the bad news at bay, and that was the continued imbalance between supply and demand. And that factor will continue to underpin the sector in the year ahead, assuming that the economy stays healthy.
This remains a crucial point because would-be homebuyers are quick to react to any sign of rising unemployment, higher interest rates and the economy’s general wellbeing. However, the signs are that all three indicators are likely to remain stable in the near term, even though there will undoubtedly be millions of words written on the timing, benefits and drawbacks associated with the UK leaving the European Union.
The housing shortage is a well-established problem that the government has made mixed attempts to address. First-time buyers have been given a range of incentives to help them reach the first rung of the housing ladder, notably the Help to Buy scheme, which now forms a significant part of all sales for some builders. Mortgage rates are also at record lows, and while inflation is already rising as a result of sterling’s weakness, the Bank of England is reluctant to respond in a way that will limit economic growth.
The effects of imported inflation on the sector are likely to be minimal, as few raw materials are imported. This is good news, not least because build cost inflation will continue to feature as a result of the shortage of skilled labour. This problem is being tackled with more apprentices and imported labour, although the latter could be affected by Brexit, but not just yet. In addition, land price inflation is extremely benign, and housebuilders have set themselves strict performance hurdles on return on capital employed and margins when it comes to purchasing, which means that land owners will struggle to push prices higher. Although it is slowing, house price inflation should continue to more than cover any increase in building costs.
Prices rose in the last four months of 2016, but it looks as though this strength may not have carried into the new year. This is partly because higher prices will continue to reduce the ability of potential buyers to increase the size of their mortgage. That said, surveyors have consistently reported a lack of any increase in sales instructions, which means that the supply of existing houses will remain tight.
One sector of the market that, although relatively small, will play an increasingly important role is build-to-rent. Driven by a need to generate a decent but safe return, institutional money is slowly being diverted into this area in search of a better yield than available on traditional fixed income. This will help to boost output towards a government target of 1m new homes by 2020. With a £2.3bn housing infrastructure fund, a white paper due on housing and the unlocking of a number of brownfield sites, Redrow (RDW) chief executive John Tutte says that this year could see housing completions reach 200,000 for the first time since the financial crash.
There are some major developments in the pipeline, including Ebbsfleet Garden City in Kent and Colindale Gardens in north London. It would be interesting to gauge the appetite for thinking outside the box and building more new towns such as Basildon and Milton Keynes, although such grand plans are perhaps unlikely. Overall, the housebuilders are likely to remain in a sweet spot this year, lest there be a big drop in buyer confidence with the triggering of Article 50, or onerous regulation proposed.
More emphasis seems likely on so-called affordable housing, with moves to speed up the planning process and provide funding for local authorities and housing associations to pay for more social housing. Housebuilders already have an element of affordable housing in their overall output, and are thus ideally placed to benefit from any move to accelerate build rates.
| Price (p) | Market value (£m) | PE (x) | Yield (%) | 1-year change (%) | Last IC view | |
| Barratt Developments | 517 | 5,201 | 9.4 | 3.5 | -8.8 | Buy, 499p, 7 Sep 2016 |
| Bellway | 2,556 | 3,136 | 7.8 | 4.2 | -1.8 | Buy, 2,363p, 18 Oct 2016 |
| Berkeley Group | 2,890 | 4,023 | 8.2 | 6.9 | -15.7 | Buy, 2,630p, 5 Dec 2016 |
| Bovis Homes | 819 | 1,102 | 8.2 | 5.0 | -6.3 | Buy, 815p, 28 Dec 2016 |
| Countryside Properties | 242 | 1,087 | 14.8 | 1.4 | NA | Buy, 230.8p, 30 Nov 2016 |
| Crest Nicholson | 504 | 1,282 | 9.3 | 4.4 | -0.7 | Buy, 486.2p, 24 Jan 2017 |
| Galliford Try | 1,348 | 1,117 | 10.2 | 6.1 | -4.2 | Buy, 1,197p, 14 Sep 2016 |
| McCarthy & Stone | 161 | 865 | 10 | 2.8 | -41.6 | Buy, 169.6p, 15 Nov 2016 |
| Persimmon | 1,974 | 6,090 | 10.5 | 2.8 | 4.8 | Buy, 1,878p, 23 Aug 2016 |
| Redrow | 447 | 1,651 | 8.1 | 1.8 | 6.1 | Buy, 411.5p, 6 Sep 2016 |
| Taylor Wimpey | 172 | 5,615 | 11.1 | 1.0 | -4.5 | Buy, 151.1p, 27 Jul 2016 |
Favourites: Housebuilders’ share prices have yet to recover to those prevailing before the EU referendum, but the demand for new houses remains strong. We still like nearly all of the housebuilders, especially Persimmon (PSN), Barratt Developments (BDEV) and Taylor Wimpey (TW.), which are paying dividends yielding over 5 per cent, including specials. Berkeley Group (BKG) also pays a substantial dividend, but is now proposing to buy back shares as part of the capital return. This will generate better value when considering that the modest premium to the sector average, in terms of the price to net asset value ratio, looks cheap when compared with a superior return on equity.
Outsiders: It's hard to pick an outsider in these positive conditions. Shares in Galliford Try (GFRD) have the highest book rating, although this has lost some of its relevance, while Bovis (BVS) has the lowest return on capital employed and recently lost its chief executive. But both have minimal debt and pay an attractive dividend.
