Much has been written on both sides of the Atlantic over the past year of the frenetic rise in house prices. Barely a day goes by without a house price index being released showing record breaking inflation. Since these stories are clearly popular (and unpopular...) with readers you can always be sure that each data release is met with a plethora of news coverage.
Zoopla, one of the major online property listing sites in the UK, reported average home price appreciation of 7.1% in 2021. Liverpool and Manchester topped the list of best performing cities, reporting average growth of 10.7% and 8.5% respectively.
Mortgage lender Halifax reported house price inflation of 9.8% for the UK as a whole, bringing the average price of a home to a record high of £276,000.
These numbers are nothing as compared to the USA where the average price of a home went up by 18% in 2021 according to CoreLogic's Home Price Index, the most in at least 45 years.
Based on personal experience, these numbers are comparable to certain sub-markets in North West England.
With house price growth at these inflated levels, you might expect the share prices of the UK's top house builders to be on a similar trajectory. But a quick glance at their share prices and valuations shows anything but:
Company | 1 Year Share Price Performance | P/E Ratio | Dividend Yield | Share Price vs. pre COVID Peak |
|---|---|---|---|---|
Persimmon | - 6.1% | 10.3 x | 9.2% | - 22.3% |
Taylor Wimpey | - 1.4% | 11.4 x | 5.3% | - 32.5% |
Barratt | - 2.7% | 10.5 x | 4.4% | - 22.5% |
Bellway | + 4.7% | 9.4 x | 3.9% | -30.5% |
Clearly UK house builders' share prices have not risen in line with house prices in the last two years.
When you compare their share price performance to their largest US contemporaries, things look even worse:
Company | 1 Year Share Price Performance | P/E Ratio | Dividend Yield | Share Price vs. pre COVID Peak |
|---|---|---|---|---|
DR Horton | + 13.0% | 7.7 x | 0.9% | + 42.1% |
Lennar | + 12.6% | 6.7 x | 1.1% | + 34.9% |
Pulte | + 5.4% | 8.0 x | 1.1% | + 10.3% |
NVR | + 14.9% | 16.7 x | - | + 27.9% |
Whilst the four largest US home builders' share prices are all well above their pre COVID peaks (ranging from +10.3% to +42.1%), the figures for the UK house builders are still very much below. Persimmon as the best pandemic performer of the four remains c. -22% below its previous peak in February 2020.
The reasons for this are multiple and varied (though in my opinion far from all being correct) including:
Concerns around build cost inflation
Stretched affordability for home buyers
Changes to government backed equity loans through Help to Buy and the wider legislative environment
The possibility/likelihood of rising mortgage rates
Perceptions around the strength (or lack of) for the UK economy as a whole
Memories of previous boom-bust cycles for the housing market including the disastrous 2007-09 period when many of the major house builders found themselves in extremely precarious financial health
In light of this last point, it is worth considering three key differences between today's market environment and 2007-09:
1. The UK government is the largest owner of housing equity in the country, by far.
Through the Help to Buy equity loan scheme. The total value of equity loans issued by the government since 2013 is £20.9 billion. Some of this will have been repaid since then, but a majority is likely to remain outstanding meaning that Her Majesty's Treasury is de facto the largest investor in UK houses by an order of magnitude. The UK government has a few £billion reasons not to see the housing market go into reverse.
2. Institutional investment.
In a zero interest rate world, institutional investors are starved of yield and are starting to look for it in a very big way in the UK's housing stock. Increasingly this attention is focusing on single family homes - the bread and butter of the volume house builders.
Investment in UK build-to-rent reached a record £4.1bn in 2021, up 14% on 2020 which was itself a record. With new and bigger entrants to this market seemingly announcing themselves on a weekly basis, 2022 looks set to break the record again.
Entrants to this market in the past year include Goldman Sachs, KKR, Ares, John Lewis, Lloyds Banking Group and Blackstone to name but a few. There is quite literally a wall of institutional capital targeting housing product across the length and breadth of the country. Liquidity matters. Fund flows matter. Don't hold your breath for a housing market collapse anytime soon.
3. Balance sheets.
In the run up to the financial crisis, many of the house builders were over indebted, seeking to juice their returns in a market awash with cheap credit. They paid a dear price when the bottom fell out in 2007-09 with many small and medium sized builders going under and many of the larger ones forced to raise substantial new equity just when their shares were at rock bottom prices.
This is no longer the case. Even though yields on corporate bonds remain near record lows, the volume house builders have learnt their lesson. Take Persimmon again, which has zero net debt and £1.23bn of cash on its balance sheet.
Just so we are clear on the level of pessimism surrounding these companies - Persimmon, which has been a cash printing machine for most of the last 10 years with nearly £1bn in EBITDA and an operating margin of c. 30%, currently offers a 9.2% dividend yield in the strongest housing market in recent history.
Yields on residential investment property in the institutional space are in the 3.0 - 4.5% range and trending lower. Sterling remains pretty weak vs. the dollar in the post Brexit landscape. How long before the private equity mega-funds turn their sights on buying the house builders instead of the houses?
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