10 November 2015


by Daniel Atkinson-Hope | 10 November

Against the background of a strong Q3 trading update from Persimmon last week, which you can read here , there have been a few negative comments on the sustainability of the housing market recently.

We could see little in Persimmon’s current position that supported this (margin improving, land bank strong, new land prices low, strong dividend growth, etc, etc.) but it is worth looking at the arguments for and against.

Of particular interest were the insights uncovered in the question time after the presentation of figures.

There are a few key points to note in response to some of the negative sentiment currently surrounding the housing market:

First, there is a belief that stronger regulatory oversight will adversely affect pricing. This is a clear example of excessive doom-mongering. Leaving aside for a moment the current supply/demand imbalance, which is unlikely to reduce with regulatory price interference, in reality, the Mortgage Market Review (MMR) represents little more than a codification of the existing good business practices put in place after the downturn.

The prudence shown by the lending market is supported by the industry which would prefer pricing to grow at a steady, not excessive, rate. It is worth bearing in mind that annualised house price increases over the last 40 years have been around 3%pa. Reducing price volatility should result in the housing market being more structurally sound than previously as buyers will actually be able to afford their homes. The following chart of the Nationwide First Time Buyer Affordability Index illustrates that affordability for First Time Buyers is not yet a problem:

In addition, the Bank of England’s recent informal guidance on interest rate increases suggests that the prospect for a rate rise has shifted out to 2017 and the governor has reiterated that any rise will be slow and gradual in nature.

Secondly, the bears of the sector have cited increasing costs. The cost make-up varies for each housebuilder but for a rough approximation: As a proportion of final selling price, labour is 33-35% and materials are 20-21%. All costs are expected to grow at between 2.5-3%. Most forecasts expect house price inflation of 3.5-4%. Ergo, increasing margins.

In addition, due to the benign pricing in the land market, the considerably cheap land still in the land banks and the more efficient planning processes, housebuilders are confident of delivering to the medium term targets set regardless of pricing inflation. Capital return policies across all housebuilders are also not wholly predicated on the on the above equation and thus targets continue to be achievable out to 2020 and beyond.

Furthermore, in many cases the standardisation of product offerings has cut costs and development time (implying further labour efficiencies) further but the industry is still a long way short of delivering the number of houses demanded. Should interest rates rise and more oversight affect the marginal buyer, the supply demand imbalance will grow further. This has been evident since as far back as the Barker Review in 2004, and the structural shortage in the new housing market has continued to get worse. In 2008, the government estimated that the number of households in England is projected to grow to 27.5m in 2033, an increase of 5.8m (27%) over 2008, or 232,000 households per year. Much of this will be due to the increase in single person households. The current rate of new housing starts since that time has not exceeded 140,000 and has only ever got above 180,000 twice since the turn of the century.

Unfortunately, this seemingly one way bet is reflected in the ratings of house builders shares, so any perceived negative news can be expected to promote an irrationally strong correction (like last week’s for instance). This may not be a bad thing though as it could take a bit of froth off the share price and reward supportive shareholders who hold for the long term.