It’s time to sell out of the housebuilding sector – here’s why

Newly-built home © Getty Images
Housebuilders: boom will inevitably turn to bust

If you bought shares in a housebuilder three years ago, you’re probably feeling pretty happy now. Shares in several leading firms have doubled or trebled since then.

And with house prices still rising, you may be planning to hang on to your shares for some time to come.

I think that would be a mistake. You need to remember that this isn’t a ‘buy and hold’ sector. Housebuilding is a very cyclical business. Today’s boom will inevitably turn to bust at some point. And because stock market investors normally look ahead, share prices often start to fall before the good times have ended in ‘the real world’.

So that raises two questions: is now the time to sell out of housebuilders? And are there some more attractive sectors out there?

Why people like housebuilders

Let’s start by looking at the positives for housebuilders.

The big plus point is there’s plenty of unmet demand for housing, especially in southeast England. Yet the number of new housing starts is still well below the peak level it hit in the last cycle, according to broker Brewin Dolphin. As a result, builders can sell new homes at premium prices.

What’s more, Rics (the Royal Institution of Chartered Surveyors) thinks that house prices will carry on rising until 2020.

Even better, a modest relaxation of planning rules in 2012 means that housebuilders have more scope to boost the number of housing starts if they want.

And you could argue that many housebuilders don’t look that expensive – they’re largely trading on price/earnings (p/e) ratios of ten or 11.

Trouble is, because housebuilding is so cyclical, firms in this sector normally trade on lower p/e multiples than the stock market as a whole. (A company is less attractive to investors if there’s a strong chance that profits will fall in the future, as is so often the case with housebuilders – in other words, they’re less willing to pay a high price for £1 of earnings, because they can’t be confident that those earnings will still be there next year.)

Look below at the valuations for some of the best known stocks.

Share price Current NAV Price/Book Prospective p/e
(Dec 2014)
Barratt (LSE: BDEV) 382p 228.5p 1.67 11.61
Berkeley (LSE: BKG) 2387p 1031p 2.31 10.94
Bovis (LSE: BVS) 800p 604.2p 1.32 10.7
Galliford Try (LSE: GFRD) 1188p 455p 2.61 12.6
Persimmon (LSE: PSN) 1371p 671.4p 2.04 11.3
Taylor Wimpey (LSE: TW) 109p 69.5p 1.56 11.1

 

If you look at the price/book column, you can see that Galliford Try’s share price, for example, is more than twice as high as its net assets – including its land. Granted, that’s partly because Galliford also has a separate construction business. But all of these builders are on price/book ratios that look high to me.

I’m also worried that Rics may be over-optimistic on house prices. When interest rates start to rise, we may see some forced sales of homes as some people can no longer afford their mortgage payments.

Lenders have also been forced by the regulator to tighten their rules on how much they can lend to homeowners. These new affordability criteria were only implemented last month, so they may begin to make an impact soon.


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But the most important point is that developers are starting to cut back on their landbanks, according to Brewin Dolphin. The broker says that developers are positioning themselves to make plenty of money in the short term, but not to be too vulnerable if the bubble bursts.

In other words, the housebuilders’ bosses fear that the good times will end in the next two or three years, and they don’t want to get caught out. Indeed Brewin thinks that 2016 is most likely time for a big slowdown in housebuilding. It’ll be a year after the election and interest rates will almost certainly be moving up by then.

Bigger payouts aren’t compensation enough to hang on

As these companies invest less money in land, they’re starting to return more money to shareholders. Some builders have drawn up long-term capital return plans with schedules for increased dividend payouts and share buybacks.

Thanks to these higher payouts, Brewin Dolphin reckons that income investors can stick with the housebuilders for a while yet. But growth investors – who are more interested in gaining from rising share prices – should consider getting out.

But I think that even the income investors should consider moving their money elsewhere. Although dividend payments may continue to grow for a while yet, a bad bust would trigger dividend cuts later this decade. You can probably get more sustainable dividends in other sectors – tobacco, pharmaceuticals and consumer goods spring to mind.

And as Brewin says, if you’re looking more for a mix of growth and income, the case for switching out of housebuilders is all the stronger. Once again, pharmaceuticals could be a better bet, and I also think some small-caps look like an attractive, if riskier alternative. (I highlighted some decent small-cap stocks to buy earlier this year. If you’re not already a subscriber, sign up for a free trial and you’ll get four free magazines plus access to our full web archive where you can read the article.)

Of course, another option is to use some of your sale proceeds to boost your cash balance. There’s no shame in holding some cash when a bull market is five years old and several housebuilder stocks have trebled.

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14 Responses

  1. 09/05/2014, mr clyde wrote

    This is a reasonable argument against ploughing your life-savings into a housebuilder tomorrow! But what if you bought at the bottom, and have received enough dividends, normal or otherwise, to virtually recoup your initial costs!
    I’m running my profits thank you very much.

  2. 09/05/2014, dialucrii wrote

    I’m a little confused, you agree with his reasoning in so far as it applies to new investors, but suggest it doesn’t apply to you because you have already made money in the sector? Surely it’s either a good sector to be in today or or it’s not. The amount you have made in it to date is completely irrelevant to that assessment.

  3. 09/05/2014, mr clyde wrote

    If the outcome ‘housebuilders shares will fall’ is a certainty then you would be right but it is not. It is actually a probability and the probability of success attached to the performance of my investment from inception is different to the probability attached to a new investor jumping in now. If I sell up I then have to find an investment that will have an equal or better chance of making/not losing money which is more difficult for me, therefore I’m sticking. In effect sometimes the devil you know is better than the devil you don’t.

    • 09/05/2014, mr clyde wrote

      Sorry, I mis-stated the outcome what I meant was ‘Housebuilders total return will fall’ i.e. combination of share price movement and dividends paid.

  4. 09/05/2014, Ed Bowsher wrote

    Hi mr clyde,

    Well done for buying at the bottom! I wish I had been as wise as you. And, of course, you’re welcome to run your profits. I wouldn’t claim that I get it right every time, and heck, it’s your money. :)

    That said, I agree with dialucrii, it’s where we are now that counts. Given that you seem to be primarily an income investor, there’s a case for hanging on for a while yet. But I think you should consider getting out before 2016 – don’t forget that dividends could be cut if things go badly wrong.

    Ed

    • 09/05/2014, mr clyde wrote

      Thanks Ed – was just clarifying response as you posted. Agree on 2016 though.

  5. 10/05/2014, mr clyde wrote

    I guess what I was trying to say is that, by your and dialucrii’s argument, there should only be two possible recommends for any share, namely Buy or Sell. You would be pretty unique if you didn’t accept that Hold is also valid.

  6. 11/05/2014, dialucrii wrote

    @ Mr Clyde,

    I suppose what I was getting at is that if by “prospects of success” you mean the probability of making or losing money in the housebuilding sector then I would say your chances right now are the exact same as someone entering the sector right now. The fact that you have made money up to this point only means you have been successful up to this point and perhaps therefore can afford to have a greater appetite for the risks associated with staying in the sector than someone new to it. That’s just a personal reason that you have for not getting out of the sector yet – you have profits you can afford to lose if it turns and still have been profitable overall in your investment – but that’s not really an argument against the premise of Ed’s article.

    IMHO staying invested because you can afford to lose a bit, have become familiar with the nature of the investment and can’t think of anywhere better to put your money are very dangerous reasons to be invested. Better to take your profits and sit on the sidelines until you find the next “bottom” to put your money into.

    As someone looking to sell my home and rent until the “property bubble bursts”, I may well be eating humble pie a couple of years from now!

  7. 12/05/2014, mr clyde wrote

    Dialucrii – But we agree! I agree that ‘my chances of making money right now are exactely the same as yours. But what are those chances? I also agree that Ed Bowsher has made an excellent argument that the chances of making money in the Housebuilder sector have reduced considerably. My argument is that my chances are better than yours for exactly the reason you give – I am more tolerant of risk than you i.e. the consequence for me is less. And yes, this is entirely personal and of not much use to you in your decision. However, if you do want some advice wrt your house. I work in the risk business and we use the equation: Risk = Probability of Event x Consequence of Event. Are you prepared to accept the consequence that you may never get back into the market against losing a little money in the short-term? I off-loaded my BTL portfolio between 2004 and 2006 but I sure as h*** kept the house I live in.

  8. 12/05/2014, mr clyde wrote

    I really should have read this before I posted. What I should have said was ‘My argument is that my risk is better (i.e. lower) than yours…’

  9. 18/05/2014, dialucrii wrote

    With respect I think we are a few pages apart. Our risk is exactly the same from here on in, what might differ is our Appetite for that risk, which depends on our personal circumstances. You give a good equation but “consequence of risk” is different for everyone. For me it might mean not ever being back on the property ladder, for you it might mean making 5% less this year, that’s why MW compares markets only in terms of their future direction, they can’t possibly account fit the implications for all investors of each risk/reward dynamic. Though it would be nice if they could for a tenner a month :)

    • 18/05/2014, dialucrii wrote

      For what it’s worth, I am off the view that over the next 2-5 years that the whole “on the property ladder” proposition will look and mean nothing like it has for the past 40 years. I think the “prosper by owning property” concept will dwindle as faith in fiat money declines. Ironically the property market’s increasing exclusivity will ensure it’s downfall with renting becoming an acceptable and palatable long term norm.

  10. 18/05/2014, dialucrii wrote

    Though not before the 2015 election of course!

    • 19/05/2014, mr clyde wrote

      …But ‘prosper through property’ has always been a political con – still, if you really have no faith in fiat money wouldn’t owning a real, useful asset be the best option? I would agree that renting should be completely normal as it is across most of Europe. The UK is only out of step because we have yet to recover properly from the horrors of the rent controls introduced in the 50′s & 60′s (and if Red-Ed has his way we will be right back there). However leaving that aside, outside London yields are still entirely reasonable which is part of the reason I believe there is still an argument to hold housebuilders. The risk is a continued boom & bust scenario (notably in London) driven by flawed Gov policy and reasonably articulated in the original article.

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