Recent UK house price surveys seem to show the property market is beginning to cool, so should investors steer clear of the housebuilders or does their poor share price performance this year mean the worst is already factored into their valuations?

In this article we look at the survey data, compare it with the messages coming from the housebuilders themselves and pick two stocks we think offer the right mix of growth, value and income.

SEASONAL DIP

There’s no disguising the fact that several of the most widely watched house price indices have recently shown a month-on-month fall in average prices.

The Rightmove index, which measures housing market activity and the price of property advertised for sale, saw average prices drop by 1.3% or £4,795 to £365,173 between July and August.

The immediate reaction from several analysts was to claim that rising interest rates in response to the country’s severe inflation woes were starting to weigh down the housing market.

In fact, the monthly fall was perfectly normal as asking prices typically ease back at this time of year and the scale of the decline was in line with the August average over the last decade.

Meanwhile, the Halifax and Nationwide reports, which record actual selling prices rather than asking prices and tend to lag the Rightmove survey by a few weeks, both showed a decline of a couple of hundred pounds between June and July.

UNDERSTANDING THE SITUATION

Does this mean the housing market is about to grind to a halt and prices are going to fall? Far from it.

Even though the monthly figures showed a slight decline, the annual figures show selling prices still rising by between 11% and 12%, suggesting the housing market is in rude health despite the cost-of-living crisis.

Rightmove, which has been compiling its index for 20 years, says national average asking prices more than doubled in that period (up 134%), outstripping salaries (76%) and general inflation (93%).

It puts part of the August 2022 dip down to buyers being on holiday and part down to sellers pricing ‘more competitively’ to secure a buyer quickly, as the average time from accepting an offer to completing is four months and many people want to move before Christmas.

It also notes new listings are up 12% year-on-year this month but says there is still a ‘massive imbalance’ between demand and supply with the amount of available stock almost 40% below 2019’s level.

Prices are still racing ahead in the regions, with Wales at the top of the table for annual house price inflation followed closely by the South-west of England, with rises of 14.7% and 14.3% respectively in July according to Halifax.

Price gains for bigger houses are noticeably outpacing those for smaller homes and first-time buyer properties too, with the average price of a detached house up 15% or over £60,000 in the year to July compared with 7.7% or around £12,000 for flats.

RISK FACTORS

As Shares sees it there are two things which could stymie the housing market, namely interest rates and energy bills.

After the recent rise in UK interest rates, the average monthly mortgage payment for first-time buyers putting down a 10% deposit has risen above £1,000 per month for the first time, 27% higher than at the start of the year, according to Rightmove.

As Tim Bannister, the firm’s director of property science, reflects: ‘The sixth consecutive interest rate rise, this time by 0.5% to 1.75%, will no doubt be in the minds of many would-be home-movers. Together with the rising cost of living, it will lead to reconsiderations of what they can afford to borrow and repay each month.’

Despite this, extra funds saved during lockdown, the ready availability of 90% loan-to-value mortgages and strong demand in the first-time buyer sector – 32% higher than summer 2019 – would suggest the market may cool from what one agent describes as ‘the frenzied bun-fight of the pandemic’, but prices are unlikely to go into reverse.

Meanwhile, as the latest ONS figures show, consumers are facing unprecedented strain with the official inflation rate topping 10% last month for the first time in 40 years due to sharp spikes in food and drink prices.

Younger generations – typically those buying their first home or taking a second step up the property ladder – have never known double-digit inflation, so this is likely to be something of a shock to the system.

The impact of higher energy prices from October means households are going to be under even greater strain.

THE US SITUATION

From an investor’s viewpoint, what goes on in the US matters a great deal for UK housing developers as even though none of them are active in that region, the US housing market forms a key part of consumer sentiment.

As David Jane, multi-asset manager at Premier Miton Investors (PMI), observes: ‘Anecdotal evidence suggests the recent rises in interest rates are having a material impact on homebuyers; US buyers typically take 30-year fixed rate mortgages and the cost of these has increased materially since the lows of 2021.

‘Combined with house price rises over the same period, the cost of moving home has increased materially. The housing market has often led the overall economy in the US.’

The confidence indicator from the US National Association of Home Builders fell for the eighth month running in August to 49, meaning sentiment had swung from positive to negative for the first time since the pandemic.

‘Tighter monetary policy from the Federal Reserve and persistently elevated construction costs have brought on a housing recession,’ said the NAHB’s chief economist Robert Dietz.

He is undoubtedly playing to the gallery, and visions of a financial crisis-style housing crash are far from reality, but it is worth noting some housebuilders have lowered prices by 5% to increase sales or limit cancellations.

Ratings agency Fitch recently said it expected a minor slowdown in the US housing market, although it cautioned a severe downtown – with prices falling by more than 10% and transactions down by 30% – was also ‘possible but not yet probable’.

THE INDUSTRY VIEW

It’s certainly not all clear skies for the housebuilders, but when you look at the average equity market valuation for the sector, share prices already seem to be factoring in tougher times ahead.

This year alone the share prices of the largest half-dozen UK developers are down by between 30% and 45% with only one, Berkeley (BKY), falling by less.

Yet in its latest summer forecast, the Construction Products Association predicts private housebuilding activity will grow by 1% this year and flatline next year, while house prices will rise by 6% this year – consistent with the ONS forecast of 7% – and by 2.5% next year.

Moreover, the Construction Products Association says if house price inflation continues to surprise positively and high mortgage availability supports demand, risks to its forecasts ‘may be skewed to the upside’.

In a similar vein, Shares’ conversations with building materials and merchanting firms have recorded the common view that, while the industrial and infrastructure markets may be growing faster, the new-build private housing sector is still in good health.

Although the end of the Government’s Help to Buy scheme in March 2023 may be a concern for some observers, the reality is the housebuilders have been weaning customers off the programme for some time to avoid a ‘cliff-edge’ scenario next spring.

TWO STOCKS TO BUY

We have gone for two national housebuilders, both of which have extremely solid financials underpinning their above-average dividends together with a long runway of growth as shown by their total number of plots.

Barratt Developments  (BDEV) 449.2p

Barratt Developments is the nation’s leading housebuilder. It delivered nearly 18,000 homes across England, Scotland and Wales in the financial year to June 2022.

It predominantly sells three and four-bedroom homes, which are most in demand, with limited exposure to flats and in particular London flats, which we think will serve it well as the regions are set to continue outperforming the capital.

It is the only developer to have been awarded the five-star customer rating 12 years in a row by the House Builders Federation and is one of the most highly rated firms in terms of sustainable building.

For the year to June 2022, pre-tax profits are expected to have beaten forecasts at around £1.05 billion while year-end net cash was £1.125 billion after a land spend of £1.05 billion and the £250 million acquisition of Gladman Developments.

‘We have delivered an excellent performance this year, reflecting the strong customer demand for our homes and the productivity of our sites,’ said chief executive David Thomas.

The company had forward sales, including joint ventures building affordable homes, of 13,579 units equivalent to £3.6 billion or nine months of revenues, and it aims to complete 20,000 homes a year.

Barratt has targeted a land bank of 4.5 years’ worth of development, and it expects land approvals in the current financial year to be between 18,000 and 20,000 plots.

Under its new dividend policy, the full-year payout will be based on coverage of 2.25 times adjusted net income, and the board will update shareholders on its capital allocation policy – such as the potential for more special dividends and buybacks – with its results scheduled for publication on 7 September.

Even without any special dividends or buybacks, the shares currently yield over 8% and trade on a similar price to earnings ratio as they did during the onset of the pandemic and, going back much further, before the global financial crisis.

Vistry (VTY) 832p

Our second choice is Kent-based developer Vistry, which was named Best Large Housebuilder last year at the Housebuilder Awards. It operates around 200 sites across England both under the Vistry and Bovis banners as well as in partnership with local authorities providing affordable and social housing.

Results for the first half to June ‘significantly exceeded’ the firm’s expectations according to chief executive Greg Fitzgerald, with the average private weekly sales rate up 11% on last year.

‘The business is in great shape and well positioned to maximise the broader market opportunities,’ said Fitzgerald.

He added: ‘Whilst mindful of the wider economic uncertainties, we are positive on the outlook and expect to see significant margin progression in the full year, with adjusted profit before tax at the top end of market forecasts.’

Private completions were up 3% to 3,219 units while partnership completions were up 24% to 1,106 units, and thanks to higher margins both divisions are seen topping their full year profit targets.

The total value of forward sales climbed 16% to £2.1 billion, representing 92% of forecast units for the year, and the firm more than replenished its land bank in the first half with returns on capital of above 25% on private plots and above 40% on partnership plots.

Net cash increased from £32 million to £115 million at the half year, and as well as paying a healthy 8%-plus dividend yield the company announced in May it would buy back up to £35 million of its shares.

Like Barratt, shares in Vistry are trading close to all-time lows on a price to earnings basis which combined with the dividend and the runway for growth makes an attractive combination.

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