Any money made during the good times is duly squandered when the market turns. This pattern of behaviour was confirmed during the financial crisis when savage land write-downs and rights issues became the norm.
Performance of indices during financial crisis
Source: FE Analytics
Given the sector’s history, investors have every reason to be sceptical. But are things really different this time? There are a number of factors to think that this may just be the case.
Housebuilders are ultimately giant sausage machines: they put land in the front-end and after some processing it comes out on the opposite side. Land pricing is therefore critical to housebuilders’ profitability since it accounts for c.20 per cent of a house’s selling price.
The current land market is incredibly benign and likely to remain so – the National Planning Policy Framework implemented by the coalition government in 2012 made it more difficult for local authorities to stymie developers.
As a consequence, planning approvals in England and Wales have surged ahead of housing starts in recent years. Councils who sought to delay implementing their required ‘five year supply plan’ in the hope of a favourable outcome at the 2015 general election will have been disappointed.
As the supply of land continues to outstrip demand from the large housebuilders, and smaller competitors remain unable to access finance, it appears unlikely that this favourable environment will change any time soon.
Pessimists often like to claim that the housing market is overheating and that any rise in interest rates will have a cataclysmic effect on the sector.
We do not think this is the case. While many London-focused economic commentators are no doubt influenced by the fact that it costs seven figures to buy a box-room in Notting Hill, outside of the capital things are less heated.
Mortgage payments as a percentage of income (ex-London) remain near record lows and base rates would need to increase by around 3 per cent to even bring these up to the long-term average of 35 per cent.
Bellway, the UK’s 5th largest housebuilder, is one of our preferred stocks in the sector. Unlike many of its peers that have sought to limit growth and distribute large special dividends to shareholders, Bellway is looking to increase the number of homes it builds by around 30 per cent over the next few years from its present figure of c. 7,700.
We think this is a sensible strategy designed to take full advantage of the current operating environment. Bellway’s management have historically been viewed as among the more conservative teams in the industry and have an excellent track record of delivering on their stated objectives. The company’s recent trading update highlighted both the strong trading conditions and the tight grip that has been maintained over construction and administration costs.
Performance of stock versus index over 3yrs
Source: FE Analytics
Bellway currently trades at a marked discount to the sector, which we do not believe is justified by the company’s operating performance.
Given the events of the past decade, it seems safe to say that management teams across the housebuilding sector have been so scarred that their behaviour has changed to an extent that would have once seemed improbable.
Investors should embrace the fact that this time it really is different.
Neil Veitch has managed the five crown-rated SVM UK Opportunities fund since January 2006.
Performance of fund versus sector and index under Veitch
Source: FE Analytics
According to FE Analytics, the £107m fund has been a second quartile performer in the IA UK All Companies sector over that time with returns of 108.02 per cent, beating its FTSE All Share benchmark by 28.99 percentage points.
SVM UK Opportunities is also outperforming both the sector and index over one, three and five years.
