Please note that tax, investment, pension and ISA rules can change and the information and any views contained in this article may now be inaccurate.
Crunch time for the property sector
Large parts of the UK population remain fascinated by house prices. Regular data from various sources fill the headlines of websites and newspapers week in, week out. Property remains one of the top talking points at dinner parties, alongside the weather and schools.
It is therefore no surprise that so many of us are interested in property as an investment – whether that’s simply owning your own home or buying shares in property-related businesses or funds.
The UK residential and commercial property market has held up better than many expected eight months ago when the UK voted to leave the EU. Shares in housebuilders were quick to bounce back from Brexit vote weakness; property funds are back in fashion; and UK house price growth accelerated at the end of 2016, adding £3,000 to the average cost of a property in one month.
Against this positive backdrop, we’re now on the cusp of a very important period for the property market, both residential and commercial.
The process to start the UK’s exit from the EU is expected to be triggered at the end of March. That could cause ripples in the UK economy and potentially disturb the property market.
We believe investors should now take the time to review their exposure to property before the sector potentially starts to wobble.
Our article looks across the full spectrum of the market, from housebuilding to conveyancing, and estate agency to commercial real estate.
SHOULD YOU BUY RIGHTMOVE or ZOOPLA?
Which would you prefer: a focused strategy with a quality earnings stream or a diversified approach which could help weather different economic cycles? That is the question investors choosing between the two main property listing sites need to answer.
Rightmove (RMV) is the clear market leader with anything upwards of a 70% share and derives almost all of its revenue from subscriptions charged to estate agents for listing properties on its site.
Zoopla seems to have accepted it cannot overtake its more established rival and instead is looking at providing a more rounded proposition to users. Its shares recently changed their name from Zoopla to ZPG (ZPG).
Gaining a unique advantage
Zoopla’s founder and chief executive Alex Chesterman has talked about creating a one-stop-shop for consumers to ‘research, find and manage their homes’. He argues the enhanced engagement with users will ‘create a unique advantage’ for advertisers.
The company recently paid £120m for property information site Hometrack, part-funded by a £76.3m share placing at 365p. The transaction follows the £160m purchase of price comparison specialist uSwitch in 2015.
Hometrack’s focus is on providing valuations to property professionals, homeowners and house buyers alike. As well as uSwitch, Zoopla already has PrimeLocation and Property Software Group in its portfolio and says it will look to complete another smaller deal in the coming months.
Zoopla used to consistently trade at a discount to Rightmove but the two companies have roughly reached parity in recent months.
Both stocks trade on an enterprise value to earnings before interest, tax, depreciation and amortisation (EV/EBITDA) of between 23 and 24. This follows a storming share price performance at Zoopla, up 73.3% in the last year against a 20.1% rise at Rightmove.
The disparity in performance reflects two factors, in our view. First, Zoopla has a bigger story to tell due to its diversification plans. Second, as the main victim of estate agent-backed challenger OnTheMarket its shares had the most to gain as this challenge fizzled out.
We prefer Rightmove's proven model
Although we like Zoopla, we prefer the proven model at Rightmove. Being the market leader creates a virtuous circle for the business.
Its site has the most listings and is therefore the one which prospective property buyers will go to when looking for their next home.
This reinforces Rightmove’s position as a must-have product for estate agencies and gives it significant pricing power when it comes to securing subscriptions from agencies.
Even if there is a property downturn, Rightmove’s services will still be required by estate agents and its subscription based model is not reliant on the volume of property transactions. The company reports its full year results on 24 February.
HOUSEBUILDERS: NOT AS CHEAP AS YOU THINK
Comment by the housebuilders over the last six months suggests there has been little impact from the Brexit vote on the public’s property purchasing habits and market prices, except at the higher end of the London market.
However, share prices are yet to fully recover from the falls seen in the immediate aftermath of the shock referendum result on 24 June 2016.
Is this an opportunity for investors to buy the sector? There is a case to be made that the fundamentals behind the UK housing market are robust. Supply cannot keep up with demand, mortgage availability is good and Government policy is supportive.
A recently published white paper offered few fresh provisions to boost housing supply. Yet UBS analysts Gregor Kuglitsch and Miguel Borrega believe preservation of the status quo is good news.
‘Given the positive environment the industry currently enjoys, we believe a “more of the same” policy strategy is positive for the stocks.’
You could certainly make the argument the housebuilders are undervalued on an earnings per share and dividend yield basis.
The average prospective price-to-earnings (PE) ratio of FTSE 350 housebuilders is 8.2 times and the average forward dividend yield is 5.2%.
Clearly the market is sceptical on their ability to hit earnings and dividend forecasts, rightly cautious on rising costs and there is an iffy outlook for prices as inflation bites.
Analysis by AJ Bell investment director Russ Mould shows margins are close to peak levels and on a price to net asset value basis housebuilders are as expensive as they have been at any point since 2007, before the financial crisis wiped billions off market valuations in the sector.
Price to net asset value is a much better way of valuing the sector than price to earnings. Therefore you could conclude the housebuilders aren’t attractive investments at current prices.
That is explained by Barratt being embroiled in a police investigation into alleged misconduct in awarding contracts for new housing developments. Bovis is clouded by allegations it had bribed homebuyers to move into unfinished properties to hit sales targets.
Housebuilders’ balance sheets are in much better shape to weather a downturn this time round but earnings and cash flow are still extremely sensitive to fluctuations in the wider property market.
And the ability to sustain profitability at current levels could be constrained by increasing labour and raw material costs.
Looking for selective exposure
We think a selective approach is appropriate if investors want exposure to this sector. We have a favourable stance towards Telford Homes (TEF:AIM). It has exposure to ‘non-prime London’, which should see continued strong demand thanks to the concentration of jobs in the capital, and an increasing footprint in the burgeoning build-to-rent market.
The company’s target to exceed £50m pre-tax profit by 31 March 2019 looks plausible, in our view, and outweighs concerns over a fairly substantial debt pile.
IS THE GAME UP FOR TRADITIONAL ESTATE AGENTS?
The market apparently thinks the traditional estate agency sector is in terminal decline.
Online challenger Purplebricks (PURP:AIM) now has a greater market value than leading estate agent Countrywide (CWD), despite the latter being far more established and already profitable. We think both stocks are good investments. Purplebricks is disrupting the market; Countrywide looks cheap.
Purplebricks offers an online service backed by freelance estate agents on the ground.
Countrywide is a more traditional estate agent. Its shares have risen by 14% since we said they were undervalued in January. On a 2017 price-to-earnings (PE) ratio of 9.6 and offering a yield of 5.6% they still look attractively valued. A solid trading update on 26 April could provide the catalyst for further gains.
The company is addressing the changes in the market, closing some of its branches and increasing its online footprint. In June 2016 it began testing a basic online service with the option to upgrade to a fuller package without any penalty later on.
We think a lot of people would take up this option as most property buyers and sellers will probably still want some hand-holding through what is likely to be among the biggest transactions of their lives.
TOP DOG IN COMMERCIAL PROPERTY SECTOR
A key development in recent years is the surge in demand for warehousing facilities as retailers adapt to exponential growth in online shopping.
The only real estate investment trust offering pure exposure to this space, Tritax Big Box REIT (BBOX) is sitting on a portfolio worth £1.9bn three years after its £200m IPO, having subsequently raised a lot of money to expand its invested asset base.
Its shares are up more than 40% on the 100p issue price to 142.7p. Jefferies recently reiterated its ‘buy’ advice with a 160p price target.
In a 19 January trading update Tritax noted ‘demand for high quality logistics assets continued unabated during 2016’ despite the Brexit vote. It pointed to ‘strong price resilience’ in the sector, with ‘modest capital value improvement’ in the second half of the year.
Even if the economic backdrop is more uncertain and shoppers face more pressures on their purse strings in 2017, the shift online is likely to continue apace and will require retailers to invest in facilities to keep up with this demand.
Investors could have another listed option in the logistics market later this year. Rumours suggest private equity firm Blackstone could float warehouse business Logicor in London, potentially valued at £11bn.
WHAT DOES BREXIT MEAN FOR REITS?
Jefferies analyst Mike Prew thinks a hard Brexit would have a substantial impact on UK REITs or real estate investment trusts.
He says: ‘The best way to go long hard Brexit is to go short UK REITs. Great Portland Estates (GPOR) sold Rathbone Square at a 4% discount to book value and was half-hearted in its return of capital.’
The transaction to which he is referring is the £435m sale of the Rathbone Square development by Great Portland Estates announced on 10 February.
The sale to German bidders Deka and WestInvest Gesellschaft was completed at this modest discount despite a good share of the floor space in the building being pre-let to Facebook as its new London headquarters. The US social media giant is paying £17.8m a year on a 15-year lease.
Only £110m of the proceeds are being returned to shareholders with the remainder retained to provide ‘flexibility’ during a period of market uncertainty created by Brexit.
The next key transaction on which Prew thinks investors should keep tabs is British Land’s (BLND) sale of its 50% interest in 122 Leadenhall Street, with a mooted sale price of £500m.
The commercial skyscraper is informally known as ‘The Cheesegrater’ and opened in July 2014.
Although he thinks there is scope for a sale at a ‘pre-Brexit’ valuation, Prew says the company has been ‘cornered into selling the wrong building’ thanks to balance sheet pressures.
He adds: ‘The sale will probably be earnings dilutive, crystalise a tax charge and dilute the quality of forward earnings.’
PRICE COMPARISON FOR PROPERTY
Oxfordshire-based ULS Technology (ULS:AIM) has made its name by disrupting one of the dullest parts of the property foodchain: conveyancing.
Its eConveyancer business-to-business platform is used by banks, building societies, mortgage brokers and estate agents to support the process of identifying and selecting solicitors to handle the legal aspects of a property transaction.
The system is able to filter by price, location, service rating, solicitor’s availability as well as the user’s requirements, and then instructs the selected solicitor directly.
The solicitor pays a fee to ULS on completion and can generate additional revenues for the business by using the platform to perform legal searches and ID checks.
ULS sees scope to grow its share of the conveyancing market from less than 2% to 10% by picking up business from big lenders; providing its services direct to consumers through price comparison site Moneysupermarket.com; and targeting housebuilders and estate agents which currently account for just 1% of its distribution.
The March 2016 acquisition of a 35% stake in HomeOwners Alliance for £575,000 is expected to support this growth push.
According to stockbroker FinnCap, achieving a 10% share of the market would imply £100m of turnover a year for ULS against a current market cap of just £65m.
Another leg to the story is provided by ULS’ platform estateagent4me which allows homeowners to compare the performance of local estate agents. (TS)