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Housebuilders – building on a patchy recovery?

With a potential housing market recovery on the cards, we look at what could be next for UK housebuilders.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

The government’s 2021 Budget was an encouraging one for housebuilders. In the near-term, Rishi Sunak has promised a buoyant housing market and a shored-up economy.

UK Budget 2021 – what investors need to know

The government’s committed to keeping a floor under housing prices, with the promise of 95% mortgages and an extended stamp duty holiday.

Longer-term though, the outlook for the UK’s housebuilders is more uncertain. The government still intends to end the stamp duty holiday eventually, and a freeze on income tax thresholds means people are going to start paying higher taxes as their wages increase.

That will weigh on the housing market as it means people could have less of their income left to be able to afford a house. Rising house prices won’t help either.

That imbalance between near-term certainty and long-term concerns is what’s kept housebuilding stocks relatively flat throughout the first three months of the year. Housebuilders have billions of pounds tied up in land and development – a sudden fall in housing prices would mean they can’t turn it around for a profit.

Fortune favours the bold… sometimes

The success or failure of housebuilding stocks ultimately boils down to how good they are at buying reasonably priced land, developing it, and selling it for a profit. Each company has its own land-buying strategy, but the pandemic has divided the builders into two camps – the bold and the conservative. Which attitude is more successful depends on the shape and speed of any recovery in the economy.

When the first round of Covid lockdowns struck, the property market shut down. But once operations restarted, some housebuilders used the opportunity to step up their land-buying to take advantage of a sudden drop in prices.

Taylor Wimpey falls firmly under the bold category. It bought 22,600 plots worth £1.3bn during the second half of 2020, financing some of the purchases by issuing new shares. To put that into perspective, the group bought 7,268 plots during the whole of 2019.

That risk could pay off if house prices remain stable, or rise over the next few years. However, if we see a downturn in the economy and the housing market starts to wobble, more conservative players like Persimmon will be in a better position. Persimmon only bought 6,827 new plots in 2020 – nearly half of what it bought in 2019.

How much house prices grow by will determine which company had a better strategy. If the market collapses, Taylor Wimpey will have stretched itself to buy land that it’ll have to sell for lower-than-anticipated margins. But if prices rise, Persimmon could fall behind for being too cautious and missing an opportunity.

There’s no way to know where house prices in the UK will go from here, but after the Budget update, some estate agents are expecting a rise. Knight Frank sees prices rising 5% in 2021, while Savills estimates a 4% uptick.

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Location, location, location

Rising property prices are good for everyone in the industry, but some might benefit more than others. The pandemic prompted a ‘race for space’ that saw people head out of big cities in search of bigger homes. That trend contributed to a 10.8% slump in City of London house prices over the past year.

If that trend continues, Berkeley, with its exposure to London, could start to see cracks form. In its latest update the group said pricing so far this year has been “stable”, but also revised the value of its reservations (deposits for agreed sales) down 20%.

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The price is right

That’s not the only place housebuilders will find themselves on unstable footing. The pandemic has had a big impact on the young – the latest labour market statistics show that nearly 50% of those rendered jobless are under 35. That will likely impact the number of people who can climb on the property ladder for years to come because they’ve missed out on up to a year’s worth of full wages – potentially more as the pandemic drags on.

Data from Halifax shows first-time buyers were already becoming hesitant before the pandemic struck. While 2020 was somewhat of an anomaly, the number of first-time buyers had already started to decline in 2019.

In 2020, the number of first-time buyers fell 13%, some of which can be attributed to lockdowns. But in the second half, when the property market reopened, the number of first-time buyers was down 2% compared to the same period in 2019. That’s worrying considering demand from the first lockdown would’ve been delayed as well.

Plus, the average house price for a first-time buyer rose 10% in 2020 alone, which creates a recipe for sluggish demand from that group.

That could shake out in a few ways for housebuilders. It could be good for Persimmon, whose homes sold for an average price of £230,534 last year. The group’s lower pricing model means it’s prepared to service the huge swathes of young people who don’t have enough cash to buy from more expensive rivals.

The group should also benefit from the government’s promise to prop up 95% mortgages and extend furlough schemes. Under the terms of the Budget, new buyers can get a loan on a £300,000 house with a £15,000 deposit rather than having to stump up £45,000-£60,000. The scheme is only available for houses under £600,000, so that prices out rivals like Berkeley.

Average Selling Price

Source: Berkeley, Persimmon, Vistry, Taylor Wimpey and Barratt IR, 2020

Vistry could also be in a prime position to outperform peers in that scenario, not because of affordability, but because of the group’s Partnerships business, which includes working with local authorities and building affordable homes. The Partnerships division makes up just over a third of Vistry’s revenue and is expected to continue growing, with management ultimately aiming for margins of over 10%.

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On the other hand, the combination of high unemployment among young people and the pandemic’s disproportionate impact on low-income households could keep that group from buying at all. That would split the UK housing market – with lower priced houses plateauing, while expensive homes continue to sell well. Berkeley stands to pull ahead in that scenario, as the average price of its homes is just shy of £800,000.

Digging for dividends

Dividends are a key reason lots of investors buy housebuilding stocks, though it’s important to remember that no dividend is ever guaranteed. While the majority of the UK’s housebuilders are expected to offer dividend yields somewhere between 4% and 5%, Persimmon stands out with a perspective yield of almost 8%. Please remember that yields are not a reliable indicator of future income.

Forecast Dividend Yield

Please note these are variable and not guaranteed. Source: Refinitiv 12/03/21

That might sound appealing, but based on 2020 performance the group’s dividend payments totalled 117% of its profits – in other words it paid out more than it made. Typically, a healthy company should be paying out somewhere between 35% and 50% of its profits – anything approaching 100% starts to look unsustainable.

Persimmon doesn’t appear to have any cashflow issues, so we’re likely to see the dividend pay-out ratio normalise in the months ahead, as profits hopefully recover. The group’s 5-year average pay-out ratio is 79% – which includes the 100%+ that the group returned in 2020. However, it’s worth keeping an eye on this. If conditions of the economy sour and profits don’t climb back to 2019 levels, that dividend will be on the chopping block.

By contrast the rest of the housebuilders’ more modest yields are well sheltered with pay-out ratios under 70% even throughout the pandemic. Berkeley in particular paid out just 36% of its profits in dividends – meaning it could be more stable. Remember though, no dividend is guaranteed.

Learn more about dividend investing

Searching for a diamond in the rough

When it comes to housebuilder stocks, each comes with its own unique strengths and weaknesses. A booming economy is a rising tide that lifts all boats, but the pandemic’s lopsided impact on different segments of the population suggests that won’t be the case moving forward.

Investing in individual companies isn’t right for everyone. You should make sure you understand the companies you’re investing in, their specific risks, and make sure any shares you own are held as part of a diversified portfolio.

This article is not personal advice. If you're not sure if an investment is right for you, please speak to a financial adviser. All investments rise and fall in value, so you could get back less than you invest. Past performance is not a guide to the future.

Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Past performance is not a guide to the future. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research disclosure for more information.


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    Important notes

    This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

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