Arguing about the UK housing market is a national sport, yet the City is in agreement: house prices are going down and housebuilder stocks are going up.
The consensus says house prices are in a Wile E Coyote moment. The lifting of the strictest phase of coronavirus lockdown measures has released pent-up demand and sellers’ asking prices have risen to match. But once that demand is met, prices will fall. The market, having already run off the cliff, will soon succumb to gravity.
Reality this week caught up with Crest Nicholson, which became the first UK housebuilder to book Covid-19 write-offs. Its asset values including land and work in progress, the industry term for what is unsold, were impaired by more than £50m to bake in anticipated falls of 7.5 per cent for the average price of residential developments and 32 per cent for commercial. The stock dropped more than 18 per cent in response.
A warning sign for investors? Not according to the analysts. Completions are expected to sink by 30 per cent this year, compared to 2019, and to spring only half way back in 2021. Undeterred, very few analysts see future house price weakness as any hindrance to stock outperformance.
Sixty-one per cent of recommendations for the large-cap builders are “buy”, according to Refinitiv data, with just 9 per cent “sell”. Price targets are on average 25 per cent above current levels. Barratt Developments, Taylor Wimpey and Persimmon, the UK’s biggest builders by volume, have 39 “buy” ratings between them and only one “sell”.
Crest is considered to be an outlier because of its weaker than average profit margins. The accounting rules say that, if the projected value of a scheme turns negative under base-case assumptions it gets impaired back to zero margin. The fatter margins earned by Crest’s peers give more buffer room and mean that, even if their selling price estimates were marked lower by double digits, that would do little damage to their balance sheets.
Optimism also reflects a belief that history is repeating. The Covid-19 response has echoes of the Great Financial Crisis of 2009 that helped form the UK’s effective oligopoly in housebuilding.
On the demand side, a withdrawal of mortgages for first-time buyers has kept pressure on the government to maintain support with its Help to Buy equity loan scheme, which is open only to new-build purchasers. On the supply side local builders are once again failing, meaning big operators can continue to tighten their stranglehold on the market.
Housebuilders often deny that they hoard land, but the evidence suggests otherwise. On average, big builders each have about four years of land bank in reserve, based on unusually high 2019 completion rates. Berkeley, the London and south-east England specialist, has more than 15 years of land bank left by the same measure. Taylor Wimpey last week cut completions guidance while simultaneously raising £500m to fund opportunistic land purchases.
Annual new housing starts in England and Wales returned to 2007 levels only last year, seven years after the introduction of a national planning framework intended to unclog the approvals process. Yet returns for housebuilders over the period have been extraordinary. Their average return on invested capital went from zero in 2010 to 20 per cent in 2016, according to HSBC.
As one of the bank’s analysts, John Fraser-Andrews, put it in the title of a recent sector note: “Cash machines are reloading”. Any extension of Help To Buy beyond its current March 2023 expiry, he said, has the potential to lift share prices by 80 per cent on average. Based on forward earnings the stocks are already trading at a small premium relative to history.
But the negatives are obvious: price deflation and fewer sales mean less cash generated. Lower completions rates may be a consequence of weaker demand, a side-effect of social distancing requirements or a combination of the two. Covid-19 complicates an industry dominated by an oligopoly protected by political expediency and raises questions over whether margins can stay so chunky forever.
Housebuilders entered the crisis with £2bn of combined net cash and are emerging with £500m of combined net debt, according to Bank of America analysis.
Weaker balance sheets combined with demand uncertainty undermine the big dividends that justify analysts’ “buy” ratings are unlikely before the year ending 2022, at the earliest. And by then the nation will be less than 18 months away from a general election, when a whole new set of risks will appear for an industry that spent the last decade growing fat on state subsidised demand.