FTSE 350 Review: Housebuilders seek stronger foundations

First, the surge in interest rates – a global phenomenon but one that was turbo-charged in the UK by the fallout from last year’s mini-Budget – is forcing many sellers to reduce asking prices and putting some buyers off entirely. This is having a direct impact on the FTSE 350 housebuilders. Last month, Crest Nicholson (CRST) posted a 29 per cent slump in forward sales by value and a 25 per cent drop by volume compared with the year before. On a market-wide level, the consensus is that there will be a 10 per cent drop in house prices this year.

Some hope the worst may be over. Crest Nicholson argued in its results that inflation has peaked, which it said means interest rates will come down and buyers will flood back to the market due to the continued structural undersupply of housing. Sky News analysis from last year found only 1 per cent of homes in the UK are vacant compared with 8.2 per cent in Germany and 13.6 per cent in Japan. While that situation persists, housebuilders will continue to have an outsized market of willing buyers.

However, the Bank of England has cautioned against assumptions that the era of high inflation is over, which means further rate hikes can’t be ruled out and rate cuts still look some way off.

Construction costs are another headache for housebuilders. In 2022, many posted strong operating profit figures thanks to an increase in revenue offsetting the rise in build costs. This year, investors should expect struggles as those revenues fall due to falling house sales while build costs stay high or potentially even increase. Price/earnings ratios, meanwhile, aren’t too different from a year ago despite all that has happened in between. That’s because the big shift has been in earnings expectations: a lot of gloom is now being priced in, which could create an opportunity for contrarians. Dividend yields are attractive for those prepared to wait.

But there are problems: even though last year’s operating profit numbers were strong, most FTSE 350 housebuilders posted IFRS 16 pre-tax losses last year due to post-Grenfell fire safety costs. In April last year, the government further expanded the scope of the buildings that it wants housebuilders and residential developers to fix for fire safety defects. The result was hundreds of millions of pounds in unforeseen spending for the housebuilders. There’s no guarantee these ‘exceptional’ costs won’t recur again this year.

Politics is also at the heart of the end of the Help to Buy scheme, due to take place at the end of the first quarter of 2023. The controversial policy has long been lambasted as both a waste of taxpayer money and a driver of higher house prices. Housebuilders, however, will be sad to see it go; Taylor Wimpey (TW), Persimmon (PSN) and Barratt Developments (BDEV) have all pointed to its end as one of the many reasons why they are slowing development this year.