Stock in Focus: A sunny outlook for house builders?
There has been some housing market data this week which has opened up an opportunity for me to write about a subject which never fails to stir readers’ interest. Housing is a particularly emotive subject in the UK, partly because it’s very cyclical (and so there is often useful read-across for investors), partly because it’s very political and partly because of our collective obsession with being a homeowner.
The problem, for me, is that timing is everything when it comes to investing in sectors as cyclical as the housing and construction market and timing the market is not easy.
For example, in October 2022 (shortly after the kami-Kwasi mini-budget of the Liz Truss mini-tenure), I wrote that the UK’s house builder valuations were not yet accounting for an anticipated decline in earnings and the shares therefore likely had further to fall. By March of the following year, house builder share prices had rallied enormously as price to earnings ratios crept up from single-digit figures. Then, I panicked and wrote another article saying I had got my timing wrong.
Fast forward another nine months and it turns out the original article was more correct than the follow up. Companies in the housing and construction industry suffered in 2023 as the housing market stumbled. High inflation and rising interest rates don’t make a great environment for companies that build or improve homes. House builder share prices hit their most recent nadir in October 2023.
Onto the news from this week which revealed UK house prices have fallen at their fastest pace in more than a decade. The data from the Office for National Statistics (released on Wednesday) said that the average selling price for a house in the UK was 2.3% lower in November than the same time the previous year - the largest annual drop since June 2011.
This news poured some cold water on the recovery seen in house builder shares in the last couple of months. An unexpected uptick in inflation in December (announced on Thursday) added further concerns to those who have invested in the cautious recovery of the highly cyclical sector.
The thing is, falling house prices is old news. ONS data is the most accurate of all the housing market data that investors get to chew on (it includes all housing market transactions, cash and mortgage deals) but it is three-months trailing. The fact that house prices were more than 2% lower in November was revealed by Rightmove’s estate agency data back in November and backed up by both Nationwide and Halifax mortgage data in December.
For those who have invested in the burgeoning recovery in the house building sector, the more interesting housing story this week comes from the Royal Institute of Chartered Surveyors (RICS) whose monthly survey reveals that estate agents are more optimistic than they have been for a while.
It is true that estate agent optimism might not seem the most reliable of data sources, but the RICS survey is actually a valuable leading indicator of the housing market. In general the sentiment revealed in the monthly survey tends to be reflected by house prices within about three months. In fact, as John Stepek wrote in his column for Bloomberg this week, “if a leading indicator worked this well for the stock market, it’d be front page news”.
And so, it’s encouraging to see estate agents looking more optimistic. They’re not yet expecting an uptick in house prices, but they’re close to the tipping point and are, on average, expecting house prices to be flat in the next three months (this the first time the outlook has been so positive since house prices began to fall in 2022).
It will be interesting to see whether this sentiment is reflected by management at the house builders when they come to announce financial results at the start of February. Annual numbers will reveal the toll that a high interest rate environment has taken on profits - forecasts are pretty bleak with earnings expected to fall by between 20% and 50% at all of the largest companies. But the key, for those interested in the sector, is not the lagging performance, but the outlook. What are house builders anticipating in 2024?
The funny thing is that selling prices have not been the problem for these companies. In 2023, average selling prices remained relatively stable among new builds, it’s the decline in the volume of sales (a side effect of the high mortgage rate environment) that has undercut profits for the house builders.
Value multiples for these companies are currently looking a bit stretched. But, in direct contrast to my article of October 2022, these multiples are based on pessimistic forecasts which could yet be revealed to be too negative.