House prices are soaring – here are the best housebuilders to buy to profit

House prices are soaring and as demand for homes continues to outpace supply – and the Bank of England appears to have mixed feelings about raising interest rates much further – there’s no indication this trend will come to an end.

In its latest trading update, Taylor Wimpey (LSE: TW) declared that despite the recent increase in interest rates from 0.5% to 0.75%, customer appetite remains strong and “healthy levels of house price growth” are offsetting labour and material cost inflation. Excluding legal completions, the company’s order book stood at £2,972m in mid-April, compared to £2,808m a year ago.

Supply is not matching up to demand

The government estimates that the UK needs to build 300,000 new homes a year to keep up with demand, but the country has consistently missed this target, with output averaging around 250,000 a year.

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Of course, supply and demand are not the only factors that influence the housing market. Interest rates and affordability are also key. And here the picture appears a bit more uncertain. UK housing affordability is near record lows while interest rates are on the up.

Taylor Wimpey might not have noticed a drop in demand after the Bank of England raised rates to 0.75%, but that could quickly change if rates jump to 2% or more as some analysts are projecting.

As well as these cracks, building costs are also rising, hitting margins, and these firms are having to set aside billions to cover the cost of dealing with cladding on old buildings. All of these challenges are bringing back bad memories of the financial crisis when hundreds of overleveraged home builders collapsed as the bottom fell out of the housing market.

Is the housing market heading for a crash?

As concerns have grown, investors have jumped ship. The sector is trading at an average forward price/earnings (p/e) ratio of around eight, compared to the FTSE All-Share average of 13.7, reflecting the market’s view that these businesses are facing serious challenges.

Still, trying to predict house prices over the long run is notoriously difficult. Housing affordability has been falling for the past four decades, yet prices have continued to march higher. What’s more, none of the major housebuilders are anywhere near as leveraged as they were heading into 2008.

At the end of 2021, Taylor Wimpey reported a net cash balance of £810m or 22p per share. Barratt Developments’ (LSE: BDEV) cash balance stood at £1.1bn (110p per share), Berkeley (LSE: BKG) held cash reserves of £846m (733p per share) while Bellway (LSE: BWY) and Persimmon (LSE: PSN) recorded cash balances of £200m (161p per share) and £1.2bn (320p per share) respectively.

While these figures will change due to working capital flows and the timing of dividend payouts, they clearly show that the sector is financially resilient. If house prices fall and the market freezes over, they should be able to adjust to the new normal.

In my opinion, these reserves take the worst-case scenario off the table, limiting the overall downside risk. It’s highly unlikely any one of these equities would fall below the value of the cash on the balance sheet – that’s without giving any attention to their land portfolios.

The cheapest of the lot, and the company with the largest cash reserves is Barratt. The stock is trading at a forward p/e of 6.4 – or five after deducting cash. Taylor Wimpey and Bellway come in second, selling at a cash-adjusted p/e of 5.8 and 5.9 respectively.

Persimmon and Berkeley are the most expensive of the bunch. These businesses are selling at ex-cash multiples of 7.4 and 8.8.

There is no denying the UK housing market is facing an uncertain future, but there is no guarantee the market is heading for a downturn either. Investors seem to be preparing for the worst, but if the worst never happens, Barratt, Taylor Wimpey and Bellway look dirt cheap. If the market does crash, their cash reserves should protect these companies from the worst.

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