High levels of inflation have been a major headwind in recent years, causing central banks to raise interest rates in a bid to bring it back under control.
Higher interest rates generally aren’t good for housebuilders. They push up mortgage costs and reduce buyer affordability, leading to lower sales and painful reading for investors.
But with stock markets expecting several rate cuts by the end of the year, could this dynamic be about to shift into reverse?
Here are three companies that are well-positioned to benefit if that’s the case.
This article isn’t personal advice. If you’re not sure an investment is right for you, seek advice. Investments and any income from them will rise and fall in value, so you could get back less than you invest. Ratios also shouldn’t be looked at on their own.
Investing in an individual company isn’t right for everyone because if that company fails, you could lose your whole investment. If you cannot afford this, investing in a single company might not be right for you. You should make sure you understand the companies you’re investing in and their specific risks. You should also make sure any shares you own are part of a diversified portfolio.
Berkeley Group
Berkeley Group is one of our preferred names in the sector. Its London focus and higher-end product, with an average selling price of £664,000 at the last count, means it offers something different from the other large builders.
Many of its sites are technically challenging, and that’s afforded it enviable margins in the past. Domestic and international demand in the key London area is likely to remain more robust than in other parts of the country.
Considering the economic challenges that housebuilders have had to wrestle with in recent times, we think Berkley’s put in a resilient showing. It’s one of the best-run builders in the sector from an operational standpoint. That meant full-year revenue and profits only fell at mid-single-digit rates, despite selling 13% fewer homes than the year before.
We expect Berkeley’s operational prowess to continue. While the order book has cooled, it still brings good revenue visibility, with around 80% of this year’s sales already locked in.
As long as costs are kept under control, the low-single-digit operating profit growth that markets are expecting this year looks well within reach.
The balance sheet is also in very good shape.
It’s sitting on a healthy net cash position, laying the foundation for the group’s plans to return £283mn to shareholders through dividends and share buybacks in the year to 30 September 2025. But remember, no shareholder returns are guaranteed.
There are some issues to keep in mind though.
Berkeley’s announced a new 10-year project to develop and rent out 4,000 new homes in the London area.
Tapping into the hot rental market while sales remain subdued makes sense, and the plan is to set up a portfolio of mature assets before looking to dispose of them.
But the issue is it’s a slower route to growth than the usual strategy of selling assets on a forward basis.
All in, Berkeley’s higher-end focus offers something different to the broader sector. Its valuation is below the long-run average which we see as an opportunity given its track record of operational efficiency. But near-term challenges remain, and there’s no guarantee of success.
Is the US housing market attractive?
Before diving into the business performance of our US pick, it’s important to understand the fundamental differences between the US and UK housing markets.
In the UK, homeowners typically have fixed mortgages for up to five years. This means that many UK mortgage holders are likely to see their payments rise as they roll off their fixed periods, regardless of whether they move home.
In the US, a 30-year fixed mortgage is the norm. The majority of US mortgages are locked in at relatively low rates compared to today’s level.
This means that if homeowners want to move, they’d have to take out a new mortgage at a much higher rate. This reduced affordability means many existing homeowners are either unable or unwilling to move.
The reluctance to give up low mortgage rates has led to sales of existing homes drying up and stifling overall supply. Given this dynamic, we think new, rather than existing, homes are set to play an important role in the US housing market.
D.R. Horton
D.R. Horton is America’s largest new home builder by volume. Third-quarter revenue rose 2% to $10bn, largely driven by an increased number of house sales.
Operating at such a large scale has afforded Horton enviable margins towards the top end compared to peers. While that’s not guaranteed to continue indefinitely, it does show the group knows how to run a tight ship and that customers trust the brand.
Another aspect we like is that the group doesn’t pigeonhole itself to just one type of customer.
It offers homes at various price points, targeted at first-time buyers, larger homes for growing families, as well as more expensive homes aimed towards luxury buyers. This diversification of property types should help at a time when all types of buyers are struggling.
Being a homebuilder in this environment brings its own challenges. Higher building costs has been keeping a lid on profitability.
Affording a new mortgage has become much tougher, keeping the housing market tight.
That’s not something we expect to change quickly, but with a track record of positive free cash flows and relatively low net debt levels, it’s something we think Horton can navigate.
The tight housing market has some benefits though. It’s helped prop up house prices and will likely continue to do so in the near term.
The strong financial position saw more than $500m returned to shareholders through share buybacks and dividends in the third quarter alone. A new $4.0bn share buyback programme has been announced. But as always, no shareholder returns are guaranteed.
While housebuilding is typically a tough sector during economic uncertainty, Horton’s position in the US market is strong. Despite the valuation being at the higher end compared to peers, the group’s scale, strong balance sheet and free cash flows make it our preferred name.
There’s no guarantee of success though, and the housing market isn’t out of the woods yet, so expect ups and downs along the way.
Remember, before you can trade US or Canadian shares, you need to complete and return a W-8BEN form – this entitles you to save tax on any dividends.
Taylor Wimpey
Back on our side of the pond, Taylor Wimpey is another name we like.
At first glance, some of Taylor Wimpey’s numbers weren’t anything to write home about. First-half revenue and operating profits fell at single-digit rates as the group sold fewer houses at lower prices.
For the full year, new home completions are set to land at the top end of its 9,500-10,000 guidance. That’s expected to bring in around £416m of operating profit, marking an 11% decline on the year before.
But it’s important to remember that markets are forward-looking, so it’s about what lies ahead that’s key for investors to consider. We think there’s potential for a recovery in the housing market to gather steam in 2025 – here’s why.
Housing affordability is a major issue. A potential homebuyer with a £1,500 monthly mortgage budget has over 10% more borrowing capacity at 4.0% than 5.0%.
Rates have already been cut once this year, and markets are expecting two more cuts by year-end. That would be a massive tailwind for buyers, increasing their purchasing power and potentially stimulating demand heading into 2025.
Planning permissions have also been a problem for the industry for some time. But since Labour’s election win, it’s moved quickly to attempt to refresh and improve the national planning framework.
The new government’s set to re-instate mandatory targets in England of around 350,000 new homes per year. It’s likely to be 2025 before the benefits of this increased level of building start to trickle through to builders. But Taylor Wimpey’s extensive landbank means it’s well-placed to take advantage when the time comes.
The balance sheet is on solid ground too, arguably one of the strongest in the sector, which is helping to support a respectable 5.8% forward dividend yield. And with the current dividend policy being linked to asset value rather than earnings, investors are more likely to receive a base level of dividend even in a downturn.
But remember, dividend policies can change and returns are never guaranteed.
Taylor Wimpey’s valuation is sitting middle of the pack when compared to peers. But its strong balance sheet and landbank help make it one of our preferred names in the sector for when the market turns.
This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. It was correct as at the date of publication, and our views may have changed since then. Investments rise and fall in value so investors could make a loss.
This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research disclosure for more information.