Where next for UK housing stocks?

At the beginning of 2017, the Brexit vote still hung over UK markets. It was widely expected that the economy would turn south, unemployment would rise and gross domestic product (GDP) growth would slow markedly. None of those things really came to pass.

A prime example of this pessimism was seen in UK housing stocks. These dropped dramatically after the vote itself, and lagged the wider market as it began to rally in the last months of the year.  A good case of this is Taylor Wimpey, which hit an eight-year high of 211p in the month before the referendum, and then dived almost 50% on 24 June.

The sector as a whole was trading at cheap valuations at the beginning of 2017. Persimmon, perhaps one of the most attractive housebuilders on valuation grounds, had a price-to-book value of two in January 2017, in line with its five-year average. In the heady days of 2015, the firm had traded at three times book value. Thus suddenly, these companies had become much cheaper. Throw in government schemes such as Help to Buy, and record low interest rates, and the outlook seemed promising indeed. Investors piled into such shares and they enjoyed a good year.

Now, perhaps, the outlook on valuation grounds is less encouraging. House price growth is expected to slow, while costs are forecast to rise by 3-4% over the year. Wages are a key part of this, and firms in the sector have flagged that a shortage of some key skills will lead to competition for labour, and thus higher wages that hit margins.

Help to Buy is expected to continue until 2021, but its future beyond this looks doubtful. Orders for new homes continue to fall too, although this has been carefully flagged. On present valuations, the major names in the sector are no longer cheap. The likes of Taylor Wimpey, Persimmon and Berkeley Group are now at a premium to their five-year average book value. Some, however, are still cheap, including Bovis Homes, Barratt and Bellway, which all trade below their five-year average book value.

Yet the undersupply of new homes in the UK isn’t going away. What we may see is a slowing of profit growth at the big firms, with a reduced pace of dividend growth. From a fundamental standpoint however, the sector does not look overly expensive, and the factors driving growth have not gone away. It is likely too soon to abandon homebuilder shares.