Shares in UK housebuilders have been soaring as the sector finally re-finds its feet following the credit crunch. The industry has come through a tough four-year patch which saw massive write downs on the value of land banks, followed by a much needed slimming down in capacity. Shareholders were tapped for more money and some were hit further with a cut or suspension in dividend payments. But that has all changed, although it won't be until next year that the last builder to recover - Barratt Developments - returns to the dividend list.
Housebuilders are perhaps one of the most predictable of cyclical performers, and should not be relied on to offer much resistance to fluctuations in the health of the economy. That said, the UK economy at the moment is far from healthy, unlike housebuilders who have recovered sharply this year, albeit from a pretty low base. Performances since January have been truly impressive in most cases. Shares in Barratt Developments are up 73 per cent and Persimmon 58 per cent, with Berkeley and Bovis bringing up the rear with a 'modest' 17 per cent. Not surprisingly, with gains like this, nearly all of the biggest housebuilders are now trading at a premium to net assets, and potential investors could be forgiven for thinking that perhaps now is a time to sell and not buy their shares.
Normally, such an idea would hold considerable merit, but circumstances are far from normal, and housebuilders really are in a sweet spot. The principal plank of support is simply that potential demand far exceeds supply. Government statistics suggest that the number of households - not houses - is projected to grow to 27.5m by 2033, an increase of 5.8m over 2008, or 232,000 households per year. Current annual house construction doesn't even come close to half this figure. True, there are around 400,000 plots with planning consent that are not being built on, because while the demand is there, potential customers are in no position to buy. Liz Peace, chief executive of the British Property Federation, made the point that simply building homes for non-existent buyers has been tried before, in Spain and Ireland, with disastrous consequences.
| Company | Price (p) | Net asset value per share (p) | Discount/Premium to NAV | Performance this year (%) | Market Cap (£m) | Gearing/cash |
| Barratt Developments | 161 | 304 | -47 | 73 | 1,570 | 6% |
| Bellway | 916 | 903 | 1 | 30 | 1,110 | 3% |
| Berkeley Group | 1,473 | 838 | 76 | 17 | 1,930 | 5% |
| Bovis | 657 | 573 | 15 | 17 | 676 | £22m |
| Galliford Try | 685 | 584 | 13 | 36 | 561 | £23m |
| Persimmon | 746 | 626 | 19 | 58 | 2,260 | £135m |
| Taylor Wimpey | 55 | 58 | -3 | 49 | 1,774 | 7% |
Building block
So what's clogging up the housing chain? The principle problem is mortgage availability. Banks are busy reducing their loan books because they are being strangled with regulations to reduce risk by boosting reserve requirements, and finding the extra funds is expensive. The simple solution is to reduce lending to all but the safest customers with a substantial deposit. No more conventional 95 per cent loan-to-value loans. There are other factors too. Potential buyers are being careful. They worry about job security, which is a real issue if the value of the house slips below the outstanding mortgage amount.
Around one in five of new houses are sold to first-time buyers, and various government initiatives have been introduced to effect a less painful step onto the first rung of the housing ladder. But while every little helps, the results have been patchy. Since the introduction of NewBuy in March, whereby the government and housebuilders underwrite an additional part of the mortgage, Taylor Wimpey has helped nearly 1,000 first time buyers through the scheme, while for Bellway there were just 133.
More recently, measures have been announced that will make it easier to extend existing homes without requiring planning consent. But this has already attracted criticism. As John Hitchcox, chairman of property firm Yoo pointed out, "If more people extend their homes, there will be less demand for new ones."
Other measures have also attracted a mixed response. Giving more power to local authorities could speed up the planning process but it could also open the gate for local activist groups to exert decisive pressure over planning decisions. Of course, everyone wants to see more affordable housing - so long as they don't have to see the houses themselves.
IC VIEW:
Housebuilders are well placed and are likely to remain so. Margins have been recovering significantly, partly as a result of a change in the sales mix away from apartments and towards family homes, and partly because an increasing percentage of the land being built on has been acquired at post-crash prices, although there is no guarantee that pressure won’t start to build on prices once again. The major dangers come from holding too much debt and expensive land when the market deteriorates. This is no longer the case. Another worry would be a significant increase in interest rates. Again, this is currently well over the horizon. If housebuilders had a wish list, it would include setting up a mortgage bank (sounds familiar) to provide affordable mortgages at affordable rates (unlike the punitive rates offered on some NewBuy offers) and a change in the stamp duty laws that would exempt purchases of say less than £300,000. We know this would work because there was a stampede last March to beat the deadline when the stamp duty exception ceiling was cut. Whether either measure is on the Treasury's radar remains a moot point.
| Favourites... |
|---|
We have buy recommendations on all but one of the UK's top housebuilders, but three stand out from the rest - two because of a promised dividend payout - and one because its share price discount to net asset value is far too large. Berkeley Group's pre-tax profit in the year to June was the biggest since 2004, long before the credit crunch kicked in, and reflects the group's decision to concentrate on up-market development of brown field sites close to central London - as it turns out the most resilient part of the property market. The shares are not cheap compared with the rest of the sector, but the attraction is in Berkeley's promise to deliver a cumulative payout of £13 a share by 2021 against a share price of £15.20p. Another top notch builder Persimmon has decided to go down much the same route, promising to return £1.9bn to shareholders between 2013 and 2021. That's about 620p a share or a yield of 10 per cent, which means that at the time of the announcement shareholders were looking at getting back their entire investment in dividends. The third top pick is Barratt Developments which only this year declared its first headline profit since 2008. It has taken that long to restructure the business to fit the more austere economic climate, and included some painful write downs that peaked in 2009 when there was a pre-tax loss of £679m. But while the turnaround is now largely in place - there is still debt of £168m although this is half of what it was a year earlier - the share price has not really reflected this. True, the shares are up 23 per cent from our buy tip (134p, 28 June 2012), and 73 per cent since the start of the year, but in relation to net asset value the shares are still at a stonking 47 per cent discount, a gap that surely has to narrow further. |
| Outsiders... |
|---|
| The odd man out in all of this is Taylor Wimpey. That's not to say that the group has been performing badly - far from it. The shares are up 50 per cent from the start of the year yet still trade just below net asset value. Moreover, profits in the half year to June more than doubled and full-year adjusted pre-tax profits are forecast to jump from £89.8m to £160.8m. But the group has struggled to make the adjustment that other housebuilders made. And it was only last July that it managed to complete the sale of its loss-making US arm for £732m. While debt levels have fallen, there was still net debt at the half-year of £135.2m. What's more, the pension fund deficit has risen sharply and is now equivalent to 21 per cent of the group's market value, and it was only this year that dividend payments were restored. |
