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What’s next for Housebuilders?

We take a look at the current state of play for Housebuilders and share our outlook for the sector.

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 last couple of years have brought with them some cushty conditions for housebuilders. Mortgage availability has been high, house prices have boomed, interest rates remain low by historical standards and government buying schemes all came together in a perfect recipe for success. Housebuilders have reaped the rewards.

As we move through the early parts of 2022, house prices show little sign of slowing down - at least if you follow traditional house price indexes. Average prices in March were up 11% year-on-year at just north of £280,000.

With this mind, it might then come as a surprise that the UK’s 4 largest housebuilders have, on average, seen their valuations fall by around 20% so far this year.

Big Four UK Housebuilders Total Return

Scroll across to see the full chart.

Source: Refinitiv, correct as of 13/04/22.

So, why is this? The key thing to remember is markets price for the future and not the present. Conditions in the here and now might remain supportive for housebuilders and their profits, but what’s next is arguably more important.

As an investor, you need to understand not only how individual companies are performing. But also have a grasp on how wider issues impact the sector.

Our share research team do a lot of the hard work for you. We cover many of the market’s most popular stocks and sectors, including housebuilders, offering company research and sector insight. To get our weekly Share Insight email delivered straight to your inbox, sign up now.

Investing in individual companies isn’t right for everyone – it’s higher risk as your investment is dependent on the fate of that company. If a company fails, you risk losing your whole investment. 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 unsure whether an investment is right for you, seek advice. All investments and any income they produce can fall as well as rise in value, so you could make a loss.

Economic outlook – have housebuilders peaked?

One of the major concerns for markets right now is how much longer house prices can be supported at current or even higher levels. A squeeze on household finances from rising living costs should, at some point, start to take its toll on demand.

Office for National Statistics (ONS) figures from January showed property costs an average of 9.1 times earnings – up from 7.9 a year earlier. And, there’s a limit to how high this can go. Real wages are falling and with inflation reducing people’s spending power, inflated house prices are a concern that markets are pricing in.

Mortgage rates on the rise

Another key factor for housebuilders is interest rates. Mortgage costs typically trend in line with the UK’s base rate, which means higher rates translate to more expensive mortgages.

A growing number of banks have started to factor in higher prices into their mortgage calculations, so borrowers might not be able to get as much as they previously could. Some providers could start to tighten lending as we go through the spring, which has the potential to put the brakes on housing demand.

Source: Refinitiv, correct as of 14/04/2022.

Looking past the short-term noise, interest rates are still low by historical standards and should remain supportive of a healthy housing market for some time to come.

Can we finally move on from cladding issues?

Cladding issues for buildings between 11m-18m have been swirling for some time, with building owners passing the cost of fixing the unsafe cladding onto leaseholders – the individuals owning flats.

Earlier this year, Michael Gove, Secretary of State for Housing, looked to enforce plans to push these costs onto developers rather than the flat owners. At the time, specific details were thin on the ground, but markets reacted badly given the total costs for developers was expected in the £4bn region and the repercussions for not engaging with government plans were severe for developers.

In recent weeks, further guidance on exactly what these measures look like have been released and several of UK’s largest housebuilders have signed up to the scheme. Over 35 developers have committed a combined £2bn to fix their own buildings and the industry will cough up a further £3bn through a building safety levy over the next 10 years.

Lots of developers already had provisions set aside in anticipation of further cladding costs, though for many the expected costs have risen. Ultimately, although these costs will eat into cash that could‘ve been used elsewhere, it should be a short-term issue that once resolved puts the matter to bed.

Cash is still flowing

Despite some of the headwinds and additional costs mentioned above, the big four housebuilders are still expected to generate just shy of £1.4bn in free cash over the coming financial year.

They’re also each sitting on healthy net cash positions putting the balance sheets in good stead. This highlights the strengths that still linger in the housing market and puts housebuilders in a position to weather a certain level of ups and downs.

For housebuilders, strong cash flow generation has two main benefits. The first is the ability to afford dividend and buyback schemes, which keep investor sweet. We saw evidence of this off the back of last year’s performance, with the big four all announcing bumper shareholder returns.

The second benefit is the freedom to go out and buy more land. For housebuilders, future growth is predicated on having a strong pipeline of potential development sites. Every company takes a different approach, but each year millions of pounds is poured into snapping up new plots of land – and you need a healthy cash flow to pay for it.

The amount of land buying is also a telling indication of how the builders themselves view the current market – you’re likely to slow down buying if you expect the markets to stagnate. Overall, there’s little sign of land buying slowing down which is a stamp of approval on the sectors' outlook from the builders themselves.

Is now the time to look at housebuilders?

With valuations under some pressure in 2022, now could be a good time to look at the sector. The big four names all trade on price-earnings ratios below their 10-year averages. There are certainly some challenges ahead and markets have priced accordingly, but the UK housing market sits on strong foundations, and this could present an opportunity if you’re willing to accept some volatility in the short-term, though of course nothing is ever guaranteed.

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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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