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UK housebuilders – back in fashion?

After heavy falls in the wake of the Brexit vote, are shares in UK homebuilders attractive for investors?

All trading involves risk. Losses can exceed deposits.

The UK housebuilding sector has had an interesting year. In the first-quarter, talk of excessively high valuations was being bandied around, after a steady multi-year rally in their share prices thanks to strong demand for new homes and a seemingly unstoppable upward trend in house prices. Then came Brexit, and millions of pounds were wiped off the sector’s market capitalisation. Since Brexit, bargain hunters and momentum investors have bought in, but with the ‘fire sale’ done and dusted, does the sector still offer anything for the longer-term?

For those with a long-term view, there are three key factors to consider. The first is the demand for new housing in the UK and its associated problem, persistent low levels of supply. In the late 1970s, the UK built around 380,000 houses a year. This had fallen to 150,000 by 2014-2015, with even that small number being an improvement on the dismal levels on 2009-10, when only 135,000 were constructed. The number of new households has exceeded the number of homes built in each year since 2008, according to researchers at the Commons Library, increasing house prices and decreasing home affordability. The oft-quoted house price-to-earnings ratio for first-time buyers now stands at around five times for the UK as a whole, versus around three-point-five for the north of England and a whopping nine times earnings for London. As a result, even if housebuilding rates increase, the UK still has a big deficit to make up, keeping home prices steady and providing good income for housebuilders.

Secondly, we have the UK’s low interest rate environment, something that has come sharply into focus since the Bank of England cut rates to new record lows in August. Lower borrowing costs do make it easier for buyers to get on the ladder, and if the experience of the Federal Reserve in the US is anything to go by, fears of higher rates and their impact on overstretched borrowers look overdone. Low interest rates are a double-edged sword for first-time buyers, since these encourage other investors to diversify into property for rental purposes as a means of gaining income. As a result, demand for new property gets stronger still, putting yet more upward pressure on prices. Even the Bank of England’s chief economist acknowledges that many people now prefer to invest in property rather than in their pensions, since they can get better yields on houses and rents than they can in anything but a stocks and shares ISA.

The UK’s employment picture is the final piece of the puzzle, in that job growth has remained strong despite a Brexit wobble. In August, the employment rate hit a record of 74.5%, and while wage growth is not as strong as either workers or the Bank of England would like, it is true that falling mortgage rates do provide an ability for new buyers to find the funds for a house purchase. So far the City of London has not been hit by Brexit woes, so this vital engine of demand for accommodation in the capital and the south-east is still going strong, and with transport links improving and expanding, commuters may find themselves considering areas outside of the Home Counties in order to get on the housing ladder.

In addition to the above, we should remember that house builders have built up substantial land banks, with firms in possession of enough to build on for five years, based on current plans, without any need to buy more. The sector could essentially go into hibernation on the land-buying front without any real hit to its outlook. This outlook supports the valuations and dividends on offer in the sector, which currently trades at 16 times earnings with a yield of 3.36% which compares to the FTSE 100’s current PE of 57 and dividend yield of 4%.

The UK is suffering from chronic under-supply in housing, combined with strong demand and a steady employment backdrop. Despite their post-Brexit fall, housebuilders still look compelling value, with the overvaluation concerns of the first few months of 2016 now behind us.

This information has been prepared by IG, a trading name of IG Markets Limited. In addition to the disclaimer below, the material on this page does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. IG accepts no responsibility for any use that may be made of these comments and for any consequences that result. No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such is considered to be a marketing communication. Although we are not specifically constrained from dealing ahead of our recommendations we do not seek to take advantage of them before they are provided to our clients. See full non-independent research disclaimer and quarterly summary.

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