Seemingly aware, policymakers were trying to tackle the issue: the much publicised introduction of the help-to-buy scheme in support of first time buyers, but also in the overhauling of planning procedures with the introduction of the National Planning Policy Framework (NFFP), designed to strong arm councils into approving more homes. These policy approaches, plus ultra-low interest rates, did a lot to help the UK housebuilders in 2013, laying the foundations for easy credit and strong continuing housing demand for years to come. Investors in this area – ourselves included – benefitted considerably.
This year, however, capital returns have been somewhat flat and house price rises seem to be slowing. It has led some to consider whether the market has become speculatively over-inflated and due for a much-needed correction.
The drop in confidence seems to be based on certain areas of macroeconomic weakness: mortgage lending has recently dropped, wage growth stutters behind house prices effectively capping affordability, and a lack in global confidence has weakened foreign demand.
In addition the political parties have been scrambling to write ever-more progressive policies to tackle the so-called ‘housing crisis’, acutely aware that winning in this area will earn electoral favour at the polls next May. But it has added to the sector malaise on account of policy uncertainty. Ed Balls, for example, outlined an annual mansion tax on homes over £2m but only recently clarified his position on what this might entail (although again only in the £2m-£3m range, above £3m is currently anyone’s guess).
While these concerns are fair, my belief is that the sector has paused and that in reality it is structurally poised to deliver attractive returns for many more years to come. I base this view on five industry drivers which underpin the investment case:
- Policy support – It may be true that Ed Balls’ mansion tax has led to softness in the London market, but it could also be down to four years of surging house prices. The closer we draw to the election the more clear policy should become. One thing is important to remember: cross-party support actually prevails. All are acutely aware of the housing crisis, so electoral change is unlikely to deliver dramatic swings in policy positioning.
- Loan availability growing – Total mortgage lending has slightly decreased year-on-year but first time buyer figures are looking healthy. This is helped by the growing availability of higher loan-to-value mortgages – where buyers effectively pay a smaller deposit relative to the property’s value – and where significant pent-up demand exists from restrictions in this end of the market during the years following the financial crisis.
- Industry consolidation – The squeeze has been on the smaller developers. In 1988 there were over 12,000 small housebuilders (classed as building less than 100 homes per year); by the end of 2013 there were less than 2,700. Lack of bank financing for land purchases is the reason here, driving some to peer-to-peer lending but the majority out of the market entirely. It translates to less competition for land, lowering prices for the larger builders and increasing their margins. For these reasons they are generating a lot of cash.
- Under-supply – One clear point made by Bank of England Governor Mark Carney when asked about over-heating in the housing sector was this: supply constraint has been the primary reason for price rises. Broad consensus is a target of 200,000 new homes annually; last year housebuilders barely managed 130,000. Specifically, the problem has been building sufficient affordable homes. In a recent interview, Ted Ayres, the chief executive of one of our holdings Bellway, said the government should do more in this area. The NFFP was meant to encourage the building of more affordable homes but since its introduction in 2012, only one in seven councils are compliant. It means structural under-supply is likely to continue.
- The economy – The sector is underpinned by powerful economic drivers. Wage growth remains muted but job growth is strong, GDP growth is robust and households hold lower levels of debt than they have held in a long time. Furthermore, with food and oil prices low, dampening inflation, expectations for interest rate rises have been pushed out: the first being expected in quarter one or two next year, but also making likely the on-going increases gradual. Confidence among consumers is therefore running high.
With structural advantages in mind, we have been interested in some of the larger housebuilders, investing in Bellway and Taylor Wimpey for the Henderson Smaller Companies Investment Trust. With strong management teams and economies of scale, valuations remain attractive on a number of metrics and they are handing back cash to shareholders where they can. Dividend yields are high and strong dividend growth appears set to continue.
Last year’s sector re-rating was certainly remarkable, but with valuations currently looking average rather than cheap relative to history, I think moving forward returns will be significantly more restrained. Powerful underlying drivers are in place here though. For these reasons I remain invested; after all, every Englishman needs his castle.
Neil Hermon is fund manager of the Henderson Smaller Companies Investment Trust. The views expressed above are his own.
