Despite a growing debt pile we prefer AIM-quoted housebuilder Telford Homes (TEF:AIM) to its larger peer Berkeley (BKG) as it is better positioned for the dynamics of the London property market.

Both stocks have been hit by the sector-wide sell-off sparked by the Brexit vote, yet they are very different animals. Berkeley specialises in higher end developments in the capital. Telford is focused on ‘non-prime London’ and has increasing exposure to the build-to-rent market.

Bumper sales

Foreign investors had helped to prop up prices in prime London locations. They’ve been put off by the Brexit vote, as evident by Berkeley which revealed underlying demand down 20% in its half year results (1 Dec).

The concentration of jobs in London makes it easier to predict demand for Telford’s more affordable properties.

Strong demand is reflected in its City North development in Finsbury Park where in November alone it sold 72 homes with a combined value of more than £43m.

Telford’s pre-tax profit fell 57% in the six months to 30 September to £9m but this reflected the timing of completions. The company is on track to hit full year profit guidance of £33m. Its confidence is underpinned by a 10% hike in the first half dividend.

The company’s target to exceed £50m pre-tax profit by 31 March 2019 looks plausible, in our view.

Watch the debt

Its forward order book has exceeded £700m worth of revenue. The strong levels of visibility provided by these sales means the company is set to dial up its debt to fund future site acquisitions and meet construction costs.

Canaccord Genuity forecasts £115m net debt by the financial year end in March 2017, rising to £162m a year later.

Build-to-rent or private rented sector developments see all the properties built for rent rather than sale. Increasing exposure to this space could limit borrowings in the future as the deals are typically forward funded by institutional investors.

Telford is close to exchanging contracts on a third transaction in this space having recently sold its Carmen Street site in Poplar to M&G Real Estate.

Buy signal?

Berkeley thinks its shares are cheap and has replaced some of its pledged dividend payments with a share buyback alongside first half results (2 Dec).

Chairman Tony Pidgley has an excellent record of calling property cycles but we still think Telford is the more attractive investment.

Based on Peel Hunt’s forecasts, Berkeley trades at 1.1 times net asset value, a discount to the sector average of 1.5 times, and yields more than 5%.

Buy Telford at 319p.

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