Why are housebuilders seemingly unloved while houses are so richly prized?by Andy Davis / May 18, 2017 / Leave a comment
Published in June 2017 issue of Prospect Magazine
Few facts of investment life are as widely acknowledged as the Brits’ love of property. Our instinctive trust in bricks and mortar as a home for our money stands in striking contrast to our suspicion of stocks and shares, and those who peddle them—even when it comes to shares in housebuilding companies. This is odd. After all, housebuilders make their money by producing homes that we have an apparently boundless ambition to own. And from an investment perspective these companies have some very attractive characteristics. The UK’s leading housebuilders make returns on equity (meaning their own money) of well over 20 per cent a year, very high by the standards of most businesses. They can also borrow very cheaply, so their returns on the capital they use (equity plus debt) are also extremely healthy. Their debts are mostly modest and several pay decent dividend yields. Yet despite their robust financial health, housebuilders are not richly valued by the stock market. Shares in most large housebuilders are currently priced at around 10 times their annual earnings. By comparison, the FTSE 100 and 250 indices in which they figure have long-term average valuations respectively of around 14 and 18 times annual earnings. Why are housebuilders seemingly unloved while houses are so richly prized? Maybe people believe that the more houses are built, the more likely it is that prices will falter and housebuilders’ profits will come under pressure. Perhaps they worry that Brexit will see an economic downturn along with an exodus of foreign construction workers that will push up housebuilders’ wage costs. Maybe the fear is that when mortgage rates rise, houses will become even less affordable and prices will drop, or that recent tax changes aimed at buy-to-let landlords will damp demand among buyers. Any and all of these factors could be at work. But there are points to consider on the other side as well, not least that the government’s housing white paper in February called for one million more homes by 2020. Given this is a target set by the current government, rather than one inherited from the Cameron/Osborne manifesto of 2015, we should expect the Conservatives to stick to it after the election (outlandish upsets aside). At current rates of building, one million new homes is an extremely ambitious though not impossible goal but if it is to be delivered most of the work will have to be done by the handful of big UK housebuilders that dominate the market. The extent of their dominance was illustrated beautifully in a report published by specialist property lender LendInvest in March. This pointed out that none of the UK’s 10 biggest housebuilders was established after 1990. Moreover, in 1988 the report says the UK had 12,200 small housebuilding companies (constructing between one and 100 units a year each). By 2006 there were 5,700 and by 2014 just 2,400. In a market that has lost 80 per cent of its small housebuilding companies in the past 30 years and where the leaders are harder to displace than ever—as evidenced by their rich financial returns—it seems strange that their valuations should be so pedestrian.