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We look at how housebuilders have performed so far in 2023, what could come next for the sector and the opportunities on offer.
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.
Spring selling season is typically when sales activity rises in the housing market. But given this year's tougher than normal economic backdrop, did housebuilders get their usual seasonal bounce?
This article isn’t personal advice. If you’re not sure what’s right for you, ask for advice. Investments and any income from them can fall as well as rise in value so you could get back less than you invest. Past performance isn’t a guide to the future. You also shouldn’t look at ratios on their own.
A fundamental cornerstone in investing is valuation.
In the same way that your dream home isn’t worth an unlimited amount of money, shares of a housebuilder aren’t worth an unlimited price. That’s why it’s important to take a good look at valuations.
The housebuilding sector’s enjoyed a strong run so far in 2023, posting average total returns of more than 20%.
Despite this, on a price-to-book basis, valuations are still some way lower than their long-term averages. We’d encourage investors to focus on the long-term outlook when investing, and valuations suggest there could be opportunities within the sector if current challenges can be navigated although there are no guarantees of course.
A major driver in the strong year-to-date performance has been the housing market holding up better than many had previously feared.
Investors have understandably been concerned about an impending recession, sky-high inflation, and rising interest rates – all of which can negatively affect affordability.
While markets remain challenging, the start to the year has been promising, with sales rates and demand seeing the usual seasonal bounce. This has buoyed market sentiment.
Sales rates have generally improved compared to the end of 2022, but are still below last year. Something that caught our eye was the continued use of incentives, particularly aimed at first-time buyers. Offering incentives helps to prop up sales rates, but will inevitably have a negative effect on margins.
House price indices have also suggested that pricing has proved relatively resilient. This rhymes with what the housebuilders have reported this spring season so far.
Source: Office of National Statistics (ONS), March 2023.
The recent spring trading updates showed that balance sheets look to be on fairly solid ground too. We saw that healthy net cash balances have been boosted by the sector reigning in land spend and managing works-in-progress carefully.
Affordability remains a pressure point. Sky-high inflation is already stretching potential buyers’ disposable incomes. With UK interest rates expected to rise further this year, mortgage rates are likely to tick upward. That would only compound the affordability issue, especially for first-time buyers trying to get on the ladder.
The key question from here is just how much further affordability will get squeezed and what impact this will have on housing demand and house prices. This impact remains to be seen, and we’ll be keeping a close eye on future developments.
Build-cost inflation is another issue that’s plagued the sector. It’s been running at around 8-10% this year, and the spring trading updates show little sign of this easing in the short term. As a result, we expect to see this eating into margins when more detailed results are released later in the year.
Given all the headwinds, analysts are expecting a sharp fall in sector profits this year as volumes fall by around 25% on average. If this happens, there’s the possibility that some housebuilder’s dividend policies could get revised downwards.
We’ve already seen the likes of Persimmon slash its dividend. There’s potential for others in the sector to follow suit if costs aren’t kept under control as we move through the year. Remember, dividends are variable and not guaranteed.
The spring selling season wasn’t as bad as some had initially feared. That’s been illustrated by strong share price performances year-to-date as some of the pessimism around housebuilders has been unwound.
If a severe downturn and double-digit house price declines are avoided, the current market valuations look undemanding to us on a long-term view.
Despite the recent rally, it’s important not to get ahead of ourselves. There’s still a lot of risk and uncertainty in the sector. Investors should expect this year’s profits to be lower and margins to come under pressure.
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