Investors should be cautious on having exposure to UK property-related stocks at the moment despite their stellar returns over recent years, according to Mark Martin (pictured below).
The FE Alpha Manager, who runs the Neptune UK Mid Cap and Neptune UK Opportunities funds, warns that a combination of the impending EU referendum and the fact that the UK house price-to-income ratio has climbed ever higher since 2008 suggests that the housing market could be at risk of a correction soon.
Following their torrid performance during and immediately after the global financial crisis, UK housebuilding stocks have been some of the FTSE All Share’s main drivers over the past three years as the sector has benefitted from very low starting valuations, an improving economic backdrop and the need to build more homes.
Performance of indices over 3yrs
Source: FE Analytics
In an article published earlier this month, FE Alpha Manager Mark Slater told FE Trustnet that his significant exposure to housebuilders has hugely benefitted the performance of both his income and growth portfolios over the last year in spite of choppy market conditions. 
“The house builders gave us a good performance last year. The biggest contribution [in our growth portfolio] was from Bellway which is our largest housebuilding investment and that was a 1.6 per cent contribution,” the manager said.
“We also own shares in Redrow, Barratt Developments, Bovis Homes Group and Galliford Try. As a whole, those companies gave us a 3.4 per cent contribution which is fairly significant.”
Despite this, Martin says that property prices are often highly correlated with retail sales and consumer confidence and, looking at these three factors together, he believes that a house price correction shouldn’t be ruled out of the equation at the moment.
“We’ve seen a really significant increase in consumer confidence just over the last couple of years largely driven by the recent ongoing real wage growth,” he said.
“There are some reasons in my view to be a little bit cautious about the outlook for retail sales and potentially the housing market. I’m obviously aware that many people have tried to call the top of the housing market in the UK for many years and it’s a dangerous thing to do, but equally it’s very dangerous to assume that house prices are going to continue to rise as quickly as they have done in the indefinite future.”
Having calculated the house price-to-income ratios of the UK as well as other major developed markets such as Canada, the US and Europe since the turn of the millennium, the manager points out that the UK’s ratio of approximately six times is elevated compared to both its long-term average and its peers.
He says that this hefty increase isn’t necessarily sustainable and investors should therefore approach the sector with caution.
“Clearly with things like Brexit around the corner, there is a possible catalyst for some kind of correction in house prices. It’s not something we’re forecasting necessarily or anticipating, it’s just something we’re asking that, in terms of exposure for this fund, do we want to be overweight housing exposure, retail exposure and house builders? We feel that with this kind of dynamic in place, probably not,” Martin continued.
Housebuilders in particular have proven to be a popular area of the UK market given the undersupply of housing and the continuing rise of property valuations.
Brian Cullen, who runs the SWMC UK fund, is particularly positive towards the sector and says that the structural undersupply of houses in the UK, the combination of flat land prices and increasing property prices and the increased supply of mortgage financing to consumers has created the “perfect storm” for housebuilders.
“Obviously it’s great that there’s an undersupply of housing, it’s great that [housebuilders] can buy the land very cheaply, but if no one is able to get financing or buy the houses then that’s a problem, and as we all know mortgage rates are at extremely depressed levels and that continues to be the case,” he explained.
“Help to Buy did a lot to assist with this as well and the fact that consumer demand has been very much supported by the financial sector and by regulation as well. If anything, some of the pressures you might typically see build have subsided, for example build cost inflation which is something that people who are bearish on the sector started to raise as an issue at various points and that has the cost of materials is now flat.”
However, Martin says that the valuation of housebuilders is a factor that needs to be paid attention to and points out that they are currently trading on peak multiples of peak book values.
“Warren Buffet and many other fund managers view price-to-book valuations as the most appropriate way to value housebuilders rather than price-to-earnings which are a lot more cyclical,” the manager continued.
“Over the very long term, the P/B ratios of housebuilders on the whole are at a very high level at a time when house prices themselves and therefore book values are at a high level.”
“When house prices fall you also tend to see a fall in price-to-book ratio. These are very leveraged and very geared businesses. When things are going well for housebuilders house prices are going up and we tend to get expansions in the price to book values. When they fall you get a double negative effect.”
“We do think there is increased risk in the housing market because of low affordability and high valuations.”
Since Mark Martin launched Neptune UK Mid Cap in 2008, it has provided a total return of 298.02 per cent, outperforming its sector average by 179.06 percentage points and its benchmark by 48.02 percentage points.
Performance of fund vs sector and benchmark
Source: FE Analytics
He has also been at the helm of Neptune UK Opportunities since 2015 and the fund has slightly underperformed both its benchmark and sector over this time frame. On average though, the manager has more than doubled the performance of his peer group composite since managing funds at Neptune.
Neptune UK Mid Cap has a clean ongoing charges figure of 0.82 per cent and Neptune UK Opportunities has a clean ongoing charges figure of 0.86 per cent.
