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Ash4781

Doubts Linger Over Long-term Outlook For Housebuilders

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http://www.ft.com/cms/s/0/de03babc-6831-11...144feabdc0.html

After an explosive start to the year, the housebuilding sector has slowed in recent months. Since equity markets bottomed in March, bricks and mortar - as measured by the UK Datastream home construction index - has lagged behind the wider market by 1 percentage point, with investors turning their attention to other cyclical stocks.

But with house prices having just recorded their third rise in four months (according to the Nationwide House Price Index) could the sector - which in spite of its recent underperformance is still up 25 per cent in the year to date - enjoy another run?

In the short term the answer would appear to be "yes", according to City brokers. Mark Hake, analyst at Merrill Lynch, reckons the share prices of Persimmon and Taylor Wimpey are already discounting a "worst-case" scenario for land and work-in-progress writedowns, which the most recent newsflow suggests is not going to materialise.

"We do not believe that trading will anytime soon improve significantly but from a net asset value perspective, there is a very strong case for saying that these stocks as well as Redrow have now been oversold," he says. The housebuilding team at Cazenove agree. They reckon Bellway and Persimmon are trading at an unjustified discount to NAV given the recent rise in house price and mortgage approvals, which supports their turning point thesis. This theory holds that the price-to-book valuations of housebuilders bottom a couple of months before the trough of mortgage approvals, as they did in 1992. As such, they see further gains.

Not everyone thinks housebuilders are undervalued. Robin Hardy at KBC Peel Hunt, who has a sell rating on every housebuilder with the exception of Galliford Try, is wary of using NAVs to value housebuilders because of the gap between book and open market land values. He says that when housebuilders start buying and selling land again, it will highlight the gulf between the market price and what they are valued at in the company's accounts. The fear is that the market price will be lower as international accounting standards have prevented housebuilders from fully writing down the value of their land.

In addition, one should not read too much into the various house price indices because the number of transactions has been too thin to draw meaningful conclusions. Indeed, many analysts and economists believe house prices will eventually trend lower. Mr Hardy, for example, forecasts a 35 per cent peak-to-trough decline in house values. To put that figure in context, average UK house prices fell 20 per cent between August 2007 and December 2008.

The lack of mortgage availability explains the bearishness. Although lending volumes have grown steadily since the start of the year, it is from a low base and approvals are still a long way from where they need to be.

Mr Hardy puts the annual "natural churn" of housing stock, owing to factors like trading-up, relocations, divorce, marriages, at something around 1m transactions. However, at the moment there are fewer than 500,000 buyers with access to mortgage finance. In contrast, in the five years to mid-2007, there were more than 1.4m such buyers.

Unfortunately, there seems little hope of this gap closing any time soon because of the problems in the financial sector. The mortgage securisation market, which helped drive the boom and the growth of specialist mortgage lenders, remains pretty much closed. Not only that. Banks are lending less because they are shrinking their balance sheets, as are building societies, while overseas lenders have almost entirely quit the UK market.

So, until the securisation market recovers, and mortgage finance starts to flow again, the longer term prospects for prices, and the housebuilding sector, do not look great. Sure, the likes of Taylor Wimpey and Persimmon might be undervalued by 5-10 per cent, but after that it is difficult to see them do more than treading water. The chance to make big profits in housebuilding stocks has passed. What lies ahead is a long road to recovery.

I like this article (it may just be because it's aligned to my thinking)

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