Anyone who bought into housebuilders five years ago, and held their nerve as well as the shares, would be sitting on a very nice profit. In that time, shares in quoted housebuilders have more than doubled, compared with a 30 per cent rise in the FTSE All-Share index. However, anyone jumping on the building bandwagon this time last year might have been less lucky, with shares in five of the 12 public quoted builders showing a loss. But nothing stands still, and since the start of 2017 all the shares - with one exception - have shown a rise.
So is it still worth investing in the housebuilders, given that some of the shares have already risen sharply in the post-recession recovery, and are now trading at price/net tangible asset ratios that some might regard as expensive?
In a normal market, this might be the case, but the current market is not normal. Mortgage rates are at a record low, house price inflation is moderating, unemployment is low and there are a handful of incentives for first-time buyers. All of these come at a time when there is a huge imbalance between supply and demand. On the other side of the coin, there is concern about how the UK will fare during and after the divorce from Europe. The jury remains out on this one, but housebuilders will suffer if unemployment increases, interest rates rise or supply outweighs demand. None of these seems likely in the near term, but sentiment is likely to remain vulnerable to the political twists and turns involved in Britain's exit process, which could run on for years.
However, dividend payments are very attractive, and housebuilders have been giving back some of the money they swiped off shareholders when rights issues were the call of the day in the wake of the financial crash. And these payments are expected to continue as builders have become highly cash-generative. Some, such as Persimmon (PSN) and Berkeley Group (BKG), have already set in place how much they will be paying out over the next four years, giving income-seekers plenty of visibility.
Such generosity in giving back shareholders their own money has attracted criticism from some who would argue that the current environment and the amount of free cash justify building up the land bank instead. However, these are already significant and sufficient to see the builders through the time it takes to achieve planning consent. Buying extra land also ties up money and expanding the build rate is largely dependent on harnessing the skilled labour needed. At the moment, this is in short supply after 300,000 workers walked away from the sector in the last downturn.
| Market Cap | Share price | Year-on-year change | 2017 year-to-date | Dividend yield | Price/NAV | RoE | |
|---|---|---|---|---|---|---|---|
| £m | (p) | (%) | change (%) | (%) | 2017 | 2017 (%) | |
| Barratt Developments | 5256 | 543 | -4 | 17 | 7.2 | 1.66 | 18.2 |
| Bellway | 3265 | 2810 | 11 | 14 | 4.0 | 1.45 | 21.6 |
| Berkeley Group | 4026 | 3165 | -3 | 12 | 2.7* | 1.71 | 29.1 |
| Bovis Homes | 1090 | 911 | -5 | 11 | 4.5 | 1.21 | 9.7 |
| Countryside Properties | 1035 | 237 | na | -2 | 1.4 | 1.45 | 18.1 |
| Crest Nicholson | 1405 | 553 | -1 | 21 | 5 | 1.66 | 23.9 |
| Galliford Try | 1266 | 1581 | 11 | 22 | 5.6 | 2.37 | 27.7 |
| McCarthy & Stone | 1023 | 194 | -19 | 22 | 2.3 | 1.51 | 15.8 |
| Persimmon | 6418 | 2114 | 0 | 20 | 6.4 | 2.37 | 25.9 |
| Redrow | 1825 | 495 | 20 | 16 | 1.2 | 1.42 | 21.3 |
| Taylor Wimpey | 5987 | 193 | 8 | 25 | 6.2 | 1.91 | 21.7 |
| Telford Homes | 261 | 354 | 3 | 12 | 4 | 1.18 | 15.9 |
*Not including share buybacks | |||||||
There has also been more than one eyebrow raised at current valuations, with some companies sporting what appear to be expensive price/net tangible asset ratios. This is a baseline calculation and makes no allowance for the value of the land bank because this could change dramatically if the economy caught a cold. But, just as an example, Berkeley Group calculated the gross development margin on its land bank at the end of 2016, assuming it all reached the point where houses were built and sold, at more than £6bn. That's going on for double the market capitalisation and three times net tangible assets.
So what's out there that can gatecrash the party and leave the housebuilders nursing a hangover? There are plenty of factors that could make a difference; it's just that we don't expect any of them to crop up just yet. Sterling's weakness puts up the cost of imports, but the house building sector doesn't rely on imports to any great extent. There are concerns that leaving the EU could restrict the number of skilled foreign workers currently employed to fill the skills gap. This seems unlikely as the government would make sufficient allowance for this type of worker. Furthermore, some housebuilders have little or no reliance on imported labour.
Affordability remains another key issue. New buyers have been subject to increased pressure on income multiples, as house price inflation has materially outpaced wage inflation. However, mortgage rates are at a record low, just 0.99 per cent from one building society, while first-time buyers can take advantage of the government's Help to Buy scheme and other measures to make it easier to buy property.
For the housebuilders, there remains considerable pent-up demand. Completions are currently running around the 150,000 per year mar,k against a base requirement of more than 250,000. And this is set to grow not least because at the other end of the housing chain people are living longer, so fewer properties are coming back on to the market. The government's white paper released earlier this year sets out steps to increase the supply of new homes, but it would be optimistic to expect any measure to provide a quick fix to the housing shortage.
IC VIEW
The housebuilding sector is cyclical in nature and is worth avoiding altogether when the economy is weak. That's not the case at the moment, and the major builders have learnt a few lessons - we hope - from the many burnt fingers that followed the last downturn, which in fairness was caused by the banking sector. Most pass the financial health check, with little or no debt, long land banks and costs under control, with any increases more than covered by house price inflation. The sector will retain its critics even in the good times, but unless the wheels start to work loose on the housebuilders' bandwagon, we view the sector as a must for income-seekers.
Favourites
With five of the major housebuilders paying dividends yielding over 5 per cent, and in one case over 7 per cent, income-seekers have a range of companies to choose from. Although not the biggest payer, we'd plump for Berkeley Group. This London-focused builder has underperformed the wider sector because of worries about its exposure to London. Berkeley has taken advantage of this by purchasing its own shares on the cheap. There is no debt on the balance sheet and Berkeley was one of the few housebuilders that came through the last recession without resorting to a rights issue. The current dividend payout is also in place until 2021.
Outsiders
This is a relative term because all the housebuilders are in a sweet spot; just some more than others. Bovis (BVS) stands out as one of the under-achievers, consistently delivering margins and return on capital below the sector average. The shares have jumped recently on a bid approach from Galliford Try, and now might be the best time to sell. The alternative is to allow a new management team to rebuild and address the structural issues that have led to its underperformance. But that would take time.
