Few markets are as emotional, irrational – and tragically for the British economy –strategically important as the UK housing market. Chancellor after Chancellor has either turned a blind eye to housing bubbles, or actively encouraged them, knowing how the market’s fortunes tickle the national psyche.
Bubble trouble
Arguably, we’re now in a 20-year house price bubble, driven by the steady decline in interest rates since the base rate topped out at 12% in September 1992. Since the Millennium, central bankers have responded to successive crises by slashing base rates and mortgage rates have followed: last week Yorkshire Building Society launched the market’s cheapest two-year fix, charging just 1.17%. Today, property portal Rightmove reports that UK asking prices hit a new record of £308,151 in May.
Cheap borrowing has also driven the share prices of major British builders. Barrett Developments (LSE: BDEV) is up a market-thrashing 347% over the past five years, 116 times the growth of the FTSE 100, which rose just 3%. Persimmon (LSE: PSN) rose 291%, while Taylor Wimpey (LSE: TW) beat them both by soaring a rip-roaring 357%. Can it last?
Full house
Cheap money is only partly to blame. The soaring population has also fuelled demand for housing, as has the buy-to-let bonanza. That source of growth is now imperilled by Chancellor George Osborne’s targeted tax crackdown, although first-time buyer schemes such as Help to Buy may replace lost demand.
At some point, the craziness has to stop. Interest rates can’t go any lower. The affordability ceiling must be close, given stagnating wages. The property industry is now waiting to see the impact of the 3% surcharge on buy-to-let and second home purchasers. There was a surge in sales in the run up to April, and early signs suggest demand has since dipped. It may only be temporary.
Building design
Demand for housebuilder shares has also dipped, with recent performance figures indicating a sector that may just be running out of juice. Barrett has seen its share price fall nearly 6% in the past 12 months, despite announcing an improved sales rate in the first 19 weeks of the year, as well as reporting “strong” market conditions with “good levels” of demand for new homes.
Barrett, which is aiming to return a generous £678m to shareholders over the next 18 months, may have been punished by wider forces, such as fears over the impact of the Brexit referendum, higher building costs and the harsher tone on buy-to-let.
Party not quite over
Persimmon has fared better, rising a steady 8% over the last year. Rising demand, cheap mortgages and historically low cancellation rates have kept the party going. It’s the same story at Taylor Wimpey, which is benefiting from healthy demand for new-build housing and also boasts a strong forward order book and high-quality land bank.
Some analysts have said the sector looks potentially overvalued as measured by price-to-book and cyclically adjusted price-to-earnings, but today’s P/E ratios hardly look demanding, with all three trading between 11-12 times earnings. Only an interest rate hike could inflict serious damage on the sector, but there’s little sign of that. I wouldn’t sell these stocks, but given the cyclical nature of the sector, I wouldn’t buy them today either.