House Builders Looking Lofty
CMC Markets | Dec 20, 2019 05:46
The sharp decline in global stock markets in late 2018 meant the share price of the house builders started off this year on a negative note.
The stock prices rebounded despite that the UK was supposed to leave the EU in late March. Some of the heat has left the British housing sector as some people were worried a potentially disorderly Brexit could hurt the market. The uncertainty in relation to Brexit has been hanging over the property sector, and seeing as a no-deal Brexit is still a possibility after the transition period, uncertainty could persist.
In some parts of the UK, house prices are still growing, albeit at a slower pace, while in other regions prices are falling. According to Bloomberg, London house prices have dropped by 1.7% in the past year – the largest annual drop in eight years. Despite all the chatter about Brexit uncertainty, mortgage approvals in the past two years have broadly been the same, and the same goes for mortgage lending amounts.
All the way through 2019 the Bank of England (BoE) kept interest rates on hold, which isn’t a surprise seeing as the UK had planned to leave the EU twice, but ended up requesting extensions. The UK central bank would like as much fire power as possible should the UK’s departure from the EU be disruptive. The BoE are likely to sit on their hands until Brexit actually happens. Interest rates are at rock bottom which has helped the housing sector.
The construction and infrastructure report for the third-quarter from the Royal Institute of Chartered Surveyors (RICS) highlighted that activity has cooled on account of Brexit. In the three month period, there was a net balance of 10% of participants registering an increase in work load, while between 2013 and second-quarter of 2016 the reading was 33%. The RICS market confidence indicator – which tracks workload, profit margins as well as employment, dipped to +12% from +21% in the second-quarter. A number of respondents to the survey said that credit conditions have deteriorated. In previous years, labour costs have been an issue, but they have eased in the latest-quarter. It is worth noting that 70% of the survey’s participants feel that labour costs will rise in the coming year – which would be a problem as prices are cooling.
The UK construction PMI reports have shown the industry had a respectable level of activity in January, but basically the sector has been in contraction for the rest of the year. The June reading was the weakest since 2009 – which highlights the problems in the industry.
The house building sector as a whole has a varied range of companies offering a variety of prices as well as a focus on different regions of the UK. The current stamp duty scheme which states that first-time buyers purchasing a property in England or Northern Ireland worth up to £ 300,000 pay zero tax. If you are buying property worth £500,000 or more, you only pay stamp duty on the £200,000 component – provided you are a first-time buyer. The government scheme is aimed at helping younger people get on the property ladder, but it is of bigger assistance to construction companies that have lower average selling prices.
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Persimmon (LON:PSN) are based in York, and they focus on building in northern England plus the midlands, and their average selling price is less that £217,000. In August, the group confirmed that more than half of private sales were to first-time buyers. In the middle of the price band you have the likes of Taylor Wimpey (LON:TW), Barrett Developments, Redrow (LON:RDW) and Bovis Homes (LON:BVS), who average selling prices range between £261,000 and £342,000. Berkeley Group are at the top end of the range as the average selling price is £644,000. Berkeley’s prices are coming down too as the group is now operating in places like Winchester and Birmingham in a bid to diversify away from the grater London area.
Seeing as profits and house prices are cooling, some firms might be tempted to slow down their rate of building in a bid to temper supply, and in turn help cushion the cooling of the market. Given that there is a housing crisis, and prices are still out of reach for many, the government might seek to put pressure on any house builders that are seen to be hoarding land. The problem from builders is that wages as well as material costs are elevated, and they will eat into profit margins.
Despite the cooling in house prices, it has been a fantastic year for the house builders in terms of profits. In 2019, Persimmon (LON:PSN), Bovis Homes (LON:BVS), Barrret Developments, and Redrow (LON:RDW) all posted record profits, although some companies revealed a slip in the latest first-half results. It is clear that Berkeley Development’s peak profits are behind them – the high was in 2018. In the latest update, Berkeley confirmed that six month profit fell by more than 40%. We could be at a tipping point for earnings at the house builders.
The house building sector might be under additional scrutiny after concerns were raised about the standards of Persimmon (LON:PSN) properties. According to an independent report, the group does not have an agreed minimum standard for all houses built. One property was found to have over 700 defects. The damming report could spark a debate about standards as well as regulation across the sector, and should that be the case, costs are likely to increase. Given the lofty profits home builders have been banking recently, politicians might want to be seen as if they are taking a tough stance against the companies.
Bovis Homes (LON:BVS) and Barrett Developments were the joint top performers of the sector, as the share price of groups grew more than 60% year-to-date. Keep in mind the FTSE 100 increased by 11% in the same time period, and the FTSE 2500 is up over 23%. It says a lot about a sector when the underperformer only increased by 37%.
Looking at the price action of the house builders, traders are clearly not worried about the possibility of earnings tapering off, as many of them enjoyed a rally in the last few months. It is a little odd that the respective share prices are holding up while earnings in some cases are being pared back.
The solid win by the Conservative party in the recent general election helped drive up the share price of the house builders, but there has been a new development on the Brexit front. Judging by the plans Prime Minister Johnson has, a no-deal Brexit after the transition period at the end of 2020 might be an option, so uncertainty could continue to hang over the housing industry in 2020. There has been a belief in certain sections of the City that investment has been delayed because of Brexit, so we could see more of that. On the plus slide for the housing market, the Bank of England are unlikely to hike rates until Brexit has been wrapped up.
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