Margaret Thatcher is often credited with popularising the notion of the UK as a “property-owning democracy”, but the saying was actually coined by inter-war Conservative MP Noel Skelton in 1923, with wider distribution of property seen as a way of winning working-class votes. For the past century, extending homeownership has been a central tenet of Conservative party policy.
It was amid the news that homeownership had fallen to a 30-year low that then chancellor George Osborne introduced the first Help to Buy scheme in 2013, with the aim of getting more people onto the housing ladder and boosting new housing supply. Under the current scheme, first-time buyers with a 5 per cent deposit can receive an equity loan from the government of up to 20 per cent of the value of a newly-built property, or 40 per cent for homes in London. Homeowners pay back the proportion of the market value of the property that was borrowed upon its sale, or after 25 years.
At the time of the scheme’s launch, Mr Osborne promised “a great deal for homebuyers” and “a great support for housebuilders”. On the latter point it has certainly delivered, turbo-charging sales for Persimmon (PSN), Barratt Developments (BDEV), Taylor Wimpey (TW.), Bellway (BWY) and Redrow (RDW) – which together accounted for just over half of Help to Buy sales in England between 2013 and 2018 – since it was introduced.
The first housebuilder on that list, Persimmon, has arguably become a poster child for the scheme, responsible for almost 15 per cent of all Help to Buy sales between 2013 and 2018. During that time, completions rose 43 per cent and operating profits grew at a compound annual rate of 26 per cent, as increasing scale and efficiency pumped up margins. Against a broader rise in UK house prices, that has precipitated a high level of free cash generation and generous returns to shareholders. But the market is sceptical that can continue – the FTSE 100 housebuilder’s shares now offer an alarm-bell-ringing potential dividend yield of almost 12 per cent.
Amid growing criticisms of Help to Buy, there is a question mark hanging over it beyond 2023, which is when the scheme has been extended to by chancellor Philip Hammond. What’s more, from 2021, it will be restricted to first-time buyers, include regional property price caps and will not fund leasehold properties. The Ministry of Housing, Communities and Local Government has also said it will assess developers’ performance over recent years when awarding new Help to Buy contracts. That will keep Persimmon on its toes – the housebuilder has already been forced to hold back properties in response to criticism over the quality of its buildings and the accuracy of move-in times. That has already started to hinder sales growth, with legal completions during the first half of 7,584 6 per cent behind the same time in the prior year.
When the Help to Buy scheme was introduced, a market intervention was much needed, according to MJ Gleeson (GLE) interim chief executive James Thomson. “There was not a broad range of mortgage availability,” he said. Between 70 and 80 per cent of the housebuilder’s customers use the scheme, unsurprising given its focus on lower-priced housing in the north of England and the Midlands. Help to Buy had changed customers' behaviour, he said, with more opting to buy three- and four-bedroom houses, rather than one- or two-beds. Mr Thomson said he was less concerned about an end to the scheme, as long as mortgage lending held up.
Barratt Developments chief executive David Thomas emphasised the fact that the vast majority of Help to Buy users will still be able to access the scheme after the changes in 2021. "We hope to see the mortgage market continue to increase the number of 90 per cent-plus loan to value (LTV) mortgages available, so that if Help to Buy ends as scheduled in 2023 we don’t see a significant fall in effective demand from first-time buyers,” he said.
But while the scheme has increased the supply of housing stock – according to a recent report from government spending watchdog the National Audit Office (NAO) it has resulted in 14 per cent more new-build properties being built – rather more damagingly, it has been accused of encouraging buyers to purchase more expensive properties as new-builds typically cost around 15 to 20 per cent more than an equivalent ‘second-hand’ property. The NAO highlighted the risk that homeowners who want to sell their property soon after they purchase it could end up in negative equity if there is a decline in house prices.
Paula Higgins, chief executive of consumer advice service the Homeowners Alliance, said the group had heard from many homeowners that had used the scheme who had experienced difficulty in selling their property. “They would normally sell to a first-time buyer,” Ms Higgins said. “But [those people] can buy a new property with Help to Buy.”
The uncertainty that hangs over the future of Help to Buy is brought into sharper focus given the slowdown in house price growth – which could lead to weakening transactions – and is being outpaced by build cost inflation running at between 3 and 4 per cent this year, according to estimates from most housebuilders. All this suggests margins for most housebuilders may have hit their cyclical peak.
On the defensive
With that in mind, it is unsurprising that some of the UK’s housebuilders have opted to shift increasingly towards building affordable homes in partnership with local authorities and registered providers and away from selling private homes. They include Galliford Try (GFRD), Crest Nicholson (CRST) and Inland Homes (INL).
Inland Homes' finance director, Nishith Malde, said the group naturally had concerns about the potential end of Help to Buy. “Unless there’s an [extension] to it, it’s almost a cliff edge.” An average of between 60 and 70 per cent of the group’s private customers per site use the scheme, given Inland's focus on lower-priced housing in London and the south-east. Expanding its partnership activities has been part of preparations for such an event, he said. During the six months to March, the total current order book more than trebled to around £140m, with 496 homes for partnership housing under construction, more than double the level in the prior year.
The attractions are clear: developers are typically paid for land at the outset and the housing association values the scheme on a monthly basis, meaning payments are received as different stages of work are completed, rather than only when homes are sold. That makes the work less capital intensive, and the housebuilder does not take on the marketing or sales risk of selling properties.
However, with less construction risk comes lower operating margins. For example, Crest Nicholson’s operating margin dipped to 14.1 per cent during the first half, from 16.8 per cent in the prior year, after it switched focus from private sales growth to pre-sales and partnerships.
In balancing the trade-off between return on capital and operating margins, Mr Malde said he calculated certain finance costs that it would need to carry in the group’s profit-and-loss account after gaining third-party financing, alongside the sales and marketing risk it would take in selling homes privately. “You are typically paying 4-4.5 per cent financing costs,” said Mr Malde. “So your operating margin will reduce, but there will be no financing costs around that.”
These housebuilders will need to carry out a much greater volume of work to compensate for lower margins, which will depend on continuing political support for affordable housing. So far, new UK prime minister Boris Johnson’s plans to get more Brits on the housing ladder have mainly extended to halving stamp duty on homes over £500,000, with the aim of encouraging older owners to downsize and make more room for growing families.
For those able to shift their business models towards lower-risk partnership and affordable housebuilding, reduced margins and higher returns on capital could mean investors will need to expect lower dividend growth, in exchange for greater security of capital returns. But for housebuilders targeting the mid- and high-end part of the market, propelled by government-subsidised demand and buoyant house prices, dividend cuts seem more likely.
Banks and the mortgage mirror
If the Help to Buy scheme has proved a gift to property developers, it’s not a stretch to assume banks have done well, too. After all, since 2013, the government has extended more than £12bn in equity loans to buyers of new properties, juicing demand in a mortgage market already buttressed by low interest rates and a quasi-religious faith in rising house prices.
Indeed, the balance sheets of Britain’s banks serve as a kind of mirror to the country’s property obsession. Mortgages make up around two-thirds of their lending. In turn, this has created a residential loan market of a size unmatched by comparable European economies. At 66m, the UK’s population may be 20 per cent smaller than Germany’s, but its stock of residential mortgages was 10 per cent larger in absolute terms when measured at the end of 2018.
For investors in the lenders themselves, the perennial question is whether this national inheritance should be a source of worry.
There are good reasons to think it might. To the pessimists, the inevitability of a major house price correction – whether the product of higher interest rates, an economic shock or political intervention – threatens to leave borrowers in negative equity and lenders hammered by defaults. Others fear dogged competition in mortgage lending, apparently unbound by a shake-up of the hitherto booming buy-to-let market, can only lead to a deterioration in underwriting standards and a rise in risky lending.
Even those who see the country’s housing supply deficit, disposition toward property ownership and ever-lengthening loan terms as strong buffers to price shocks and debt servicing would admit that the return on mortgage lending isn’t what it used to be.
As major lenders are prone to warning, the balance between portfolio growth, customer retention and profitability is something of a high-wire act. On an analyst call earlier this year, Lloyds Banking Group (LLOY) chief financial officer George Culmer spoke of the bank’s suspicion at some providers’ product lines, and his “struggle to see how current rates make a decent cost of equity”. In other words, the UK’s largest mortgage lender thinks some of its peers are chasing market share at the expense of their shareholders.
Competitive pressures
Rising maturities at the start of 2019 mean Lloyds merely aspires for its open mortgage book to end the year where it began. Others are feeling the pinch, too. At its half-year results, CYBG (CYBG) spoke of both above-average growth and a need to “proactively reduce” its weighting in some mortgage lines if it is to maintain margins. Tesco (TSCO) cited “challenging market conditions” and “limited profitable growth opportunities” in its recent decision to pull out of new mortgage lending altogether, putting its £3.7bn loan book in the shop window in the process.
For further proof of the competition within the market, and to Mr Culmer’s point, one need look no further than the intense competition in the two-year fixed-rate market. The interest on the average 95 per cent LTV mortgage has dropped from 3.95 to 3.25 per cent in the past 12 months, according to financial data provider moneyfacts.co.uk, suggesting providers have been cutting in riskier segments to get in front of first-time buyers and take market share. As a reminder, it costs banks 0.75 per cent a year just to borrow from the Bank of England.
Naturally, the spectre of a price war in such a systemically-important area of the economy has not gone unnoticed. In May, Prudential Regulation Authority chief Sam Woods said regulators were watching developments in rate-setting “like a hawk”, and would consider imposing stricter minimum capital requirements on lenders.
Then again, conditions could be tougher for domestic mortgage lending. At 2.1 per cent, the UK’s weighted average interest rate is still the second highest of EU states with at least €100bn in outstanding residential mortgages, according to the European Mortgage Federation.
And while risk appetite is clearly strong, the Bank of England does not yet see signs of deteriorating asset or credit quality. In its annual Financial Stability Report, the central bank noted that the proportion of mortgages most vulnerable to house price falls — LTV ratios above 75 per cent — has been broadly flat since the end of 2017.
That observation requires some qualification. While the risk profile of the country’s total mortgage stock appears to have levelled out, the proportion of new lending with a LTV ratio of at least 90 per cent has been steadily climbing since 2010. At the same time, the proportion of new mortgages in which borrowers are taking on loans at least four times their total annual income has been climbing.
Given mortgages with higher LTV ratios are most vulnerable to house price falls, this trajectory is clearly unsustainable. But on a near-term horizon, these creeping changes aren’t a systemic threat, at least as far as the UK’s largest lenders are concerned. In 2018, they were subjected to a stress test by the Bank of England, which found that they could withstand a sudden lurch in interest rates to 4 per cent combined with a large increase in unemployment and a sharp fall in house prices. Mortgages may account for two-thirds of lending, but accounted for “only a quarter of impairments in the stress”, regulators say.
We are told borrowers are well-prepared, too. Figures from trade association UK Finance show the number of mortgages considered in arrears has been falling, and comprised just 1.09 per cent of all mortgages by April. The Bank of England estimates mortgage interest rates would have to rise by 200 to 300 basis points for the proportion of households with a mortgage debt-servicing ratio above 40 per cent to hit 1.8 per cent, which was the average in the decade prior to the financial crisis. At present, this level ranges between 1 and 1.4 per cent. And so long as interest rates remain low, so should debt servicing costs.
Disadvantages of scale?
A similar stress test is planned for 2019, although for some financial services watchers, it is the smaller, so-called challenger banks that are a greater cause for concern.
In June, the Bank of England found inadequate risk monitoring and forbearance practices and “overly optimistic” projections around balance sheet resilience among fast-growing companies geared towards buy-to-let mortgages. Although none of the deposit-taking banks was named, the market was already feeling cautious around risk management standards after the PRA found Metro Bank (MTRO) had miscalculated the risk weighting of commercial property and professional buy-to-let loans. A highly dilutive rights issue to boost its capital levels soon followed.
