UK Housebuilders – Sector Review Jan 2020
14 January 2020
The election result has clearly given the UK housebuilders share prices a shot in the arm. We expect the housing market will follow suit. More consumer confidence and housing demand should see house prices edge up, helping housebuilder margins, while there will be more upside potential for volumes. This will see the sector continue to throw off large amounts of cash which will mostly be returned to investors. This outlook allows us to reset target prices on higher P/NAV multiples and lower dividend yields.
2019. Last year was a good year for share prices even if forecasts went sideways to slightly lower. Average total returns were 57% or 46% excluding dividends.
2020 Outlook. The general election result should make consumers more confident, which should lead to increased new house appetite. The next few weeks will give us a big clue as to how much. Better volumes should lead to a modest pick-up in house price inflation which should arrest any margin decline, possibly leading to a small increase. Cash flow remains strong and along with excessively long land banks offers upside on capital returns.
Target price changes. We have reset (increased) target prices with higher target multiples and lower dividend yields to reflect the post-election outlook.
Key housing themes for 2020 Politics
– Conservative majority and Brexit (The general election result should boost housing activity)
The clear Conservative majority removes most, but not all, of the political risk for 2020 and should put a spring in the step of the UK housing market. Brexit still needs to be negotiated but we suspect most 2020 house buyers will just get on with it. The other issue to mention on the political front is the London mayor’s approach to housing, which, over the last few years, cannot be described as supportive. Any changes on this front would be helpful for those exposed to the capital.
– House price inflation (Overall we see limited price inflation in 2020)
Inflation had been drifting lower through the second half of 2019 as the Brexit rumblings continued and then concerns about the election result kicked in. There will be still be some regional variation in HPI in 2020 (with the North & Midlands outperforming and London lagging) but overall we see limited inflation in 2020 and across the forecast years at this point in the cycle.
– Build costs (We assume build cost inflation of 2-3%in 2020)
Build costs, like house price inflation, have been trending lower over the year. Conversations with management towards the end of the year had even started mentioning cost inflation getting close to zero. However, if our expectations of a post-election bounce hold good then cost inflation will start climbing again as housebuilders pick up the pace of build. Overall our forecasts are currently assuming cost inflation of c3% in CY20 and 2% in CY21.
– Margins (Sector margins have peaked for the time being)
We expect sector margins to be 19.0% in 2019, down 0.8% from the peak 2018 levels. We expect margins to be pretty flat in CY20 and again in CY21. Prior to the election we had started to become a bit twitchy about the balance of price inflation vs cost inflation slipping into negative territory in 2020. We think this risk has now subsided and that there is some modest upside risk from this mix in 2020/21.
– Volumes (We are forecasting volume growth of 2% in 2019 and 2020)
Aggregated volumes for the quoted housebuilders are expected to be c89.9k, a rise of 2% over the year, and some 10.3k above the peak hit in 2007. We are currently forecasting 2-3% growth p.a. over the next three years but see some modest upside risk to these numbers.
– Dividends (Large returns to shareholders are expected to continue)
The biggest change the sector has seen since the global financial crisis is the massive jump in dividend payments. In 2007 the total sector paid out a total of £478m in dividends. In 2019 we expect dividend payments to be c£2.8bn. With dividend cover at 1.56x in 2020E we continue to see upside risk especially given our views on the land banks.
– Land spend and cash/(debt) levels (We think there is scope for land banks to shrink)
The average sector land bank is 5.3 years. This compares with 4.8 years in 2007, 4.0 years in 2000 and closer to 3.5 years in the mid 1990s. The rise in land banks during the early noughties was driven by tighter planning rules which are now being unpicked. While more of today’s land is controlled rather than owned we still think there is plenty of scope for land holdings and hence capital to be reduced. This trend would further boost the expected increase in net cash the sector will hold and ultimately dividends or share buy back.
– The budget (We think the budget will feature changes to Stamp Duty)
While the date of the 11th March is a bit later than expected the first budget from this Tory Government (and Sajid Javid) will be a clear tone setter on many fronts, housing included. The scale of stamp duty rates is a prime candidate for change. We think putting zero rates on properties up to £500k, along with shifting the bands up elsewhere, is the sensible approach. This would help serve the majority of the retirement market but we would not be that surprised to see other supportive measures for this end of the market.
– Help to Buy (We can’t see HTBending overnight in 2023)
The current Help to Buy (HTB) program is due to run until March 2021. From April, it will be restricted to first-time buyers and includes regional property price caps to ensure the scheme reaches people who need it most. This version of the scheme will run till March 2023. Despite this current hard cut-off date, we think the Government will look to extend it further but will look to fine tune it as well.
– Modern methods of construction (We see MMC as a way to speed up housing output)
To produce the necessary amount of housing in the UK over the next 10-20 years modern methods of construction need to be employed. While bathroom and kitchen pods as well as other pre-assembled units (dormers, porches) will be part of the answer it looks like modular building will be the main solution. What remains unclear at this stage is whether either flat pack panels or whole volumetric units will be the more successful. Our current view is that the best (either speed or cost or both) will vary by development. More capital is being deployed across the industry in each of these areas with the volumetric solutions requiring more capital but offering bigger returns. Definitely an area to watch in 2020 and beyond to see if any business really gains a competitive advantage.
– Built to Rent (BtRis a nascent but fast growingasset class)
The drive to institutionalise the rental market has only really just begun. Build to Rent (BtR) is a relatively new asset class supported by growing demand from tenants for professionally managed properties, typically with communal space and shared leisure facilities. To date c35k BtR units have been built in the UK, with a further c120k units under construction/in planning. This equates to just 3% of the private rented market with clear scope to grow further, particularly given the increasing taxes and loss of tax reliefs discouraging individual buy-to-let investing. We see more builders lending their skill set to this asset class over the coming year and beyond.
The general election result has improved the outlook for the UK housing market but it is still too early to call how strong the important spring selling season will be. The Brexit negotiation will rumble on but we think domestic policies will now move to the fore in setting consumer confidence and economic performance in 2020. Housing is still very high up on the political agenda and the sector should expect some help from the budget in March. We are still in an era of unprecedented Government support for the sector and improving the supply/demand imbalance remains a priority.