Potential government crackdowns on the sector mean Columbia Threadneedle’s James Thorne has sold out of the majority of his housebuilder exposure.
The manager of the four crown-rated Threadneedle UK Smaller Companies fund said he was concerned over the sustainability of the strong earnings growth in the sector experienced in recent years.
Housebuilders have been on a consistent uptrend since the financial crisis in 2008. As the below chart shows, the four largest UK housebuilders have returned between 435.09 and 553.87 per cent over the past eight years.
Performance of index over 2yrs
Source: FE Analytics
However, they have struggled over the last two years as investors feared that the impact of the Brexit vote last June could derail the UK housing market.
Despite the Brexit blip, the sector has enjoyed a number of tailwinds, not least the limited supply of new housing in the UK market.
As such, many have seen returns on capital reach more than 20 per cent per annum, something that Thorne has capitalised on in his fund but now is wary of.
“There is obviously restricted supply in terms of housing in the UK and there is a help-to-buy scheme in place so the underlying fundamentals look good [for the sector],” he said.
“On one argument you could say that these businesses are making 20 per cent plus return on capital and are returning all of that as cash and dividends and at the moment the market really likes income.
“I would argue that there is a point at which politically it is not acceptable to have housebuilders making a 20 per cent plus return on capital on what is a commodity business.” 
The manager said that, for a number of years, banks have been unwilling to lend capital for new projects, making it more difficult to get housing developments off the ground and reducing the supply-side further.
He said there is an irony in the fact that the government have had a large stake in the banking sector, in particular Lloyds and Royal Bank of Scotland, yet the Bank of England has voiced complaints that the banks aren’t lending to private housebuilders.
“That’s why there is this constrain to supply and why land hasn’t been bid up and why housebuilders have accelerated,” Thorne noted.
“To me at some point they have to sort all of that out because it doesn’t make any sense and at that point you will see that the housebuilders were basically making excessive returns.”
Indeed, measures against housebuilders have already begun to be put in place, with the government recently banning the sale of houses as leasehold in England.
It also will cut ground rents on properties to zero after a number of complaints were brought to the fore on the exorbitant charges and unfair contracts by some of the housebuilders.
Just this week, Taylor Wimpey reported a 23.7 per cent fall in first half profits to £205m due to a £130m charge taken by the company to provide redress to customers who were sold leasehold properties where the ground rent doubles every 10 years.
Broker Killik reduced the firm to a ‘Sell’ recommendation on the back of this, noting: “we do not believe the current valuation reflects the potential for further liabilities in relation to unfair leasehold practices, which have been the subject of increasing media and political criticism lately”.
However, Thorne warned that many remain bullish on the housebuilders as “while that treadmill is going – and it has been a slow trend – the market believes that it continues forever”.
The manager has reduced his weighting to real estate significantly in the Threadneedle UK Smaller Companies fund to just 1.8 per cent.
Having had a position as high as 5 per cent in the fund, he now owns just one housebuilder – Countryside Property.
The company has performed well over the last two years despite dropping by more than a third in the aftermath of the EU referendum.
Over the last two years it has returned 58.67 per cent, outperforming fellow housebuilders Persimmon and Barratt Developments during the period.
Performance of stocks over 2yrs
Source: FE Analytics
“We own Countryside and that is partly because of the partnerships piece which is effectively where you are building houses for local authorities,” Thorne said.
“So they never own the land they are effectively contractors which I think has greater longevity over the longer term.”
He added that this means that the firm does not have a large amount of capital tied up in new projects, though the returns are slightly less because there is no uplift from said capital appreciation.
The manager also noted that while the firm does have a housebuilding portion to the portfolio which ultimately would be cyclical, there is a balance between the two businesses.