Despite cooling UK house prices, builders are charging ahead

UK house prices are teetering on the edge. Rising interest rates and falling real wages are piling pressure on borrowers who were already facing some of the least affordable prices in recent history.

While house prices are still growing according to the latest data, cracks are starting to show. Last week a closely-watched survey by the Royal Institution of Chartered Surveyors found the net balance of buyer inquiries to estate agents was -7% in May compared with +8% the previous month – that indicates a drop-off in enquiries from buyers.

What’s more, the latest figures from the Bank of England show that the number of mortgage approvals fell to a two-year low in April.

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Over the past two years explosive house price growth has been powered by a lack of supply and easy finance. With demand now slowing and financial conditions tightening, the outlook for UK house prices is clouding over.

However, it looks as if one segment of the market is still firing on all cylinders – and there are some fantastic opportunities for investors to take advantage of to play this trend.

There are strong tailwinds in the market for new homes

It’s no secret that the UK has a chronic shortage of new homes and while credit conditions might be tightening for borrowers overall, demand for new properties seems to be holding up fairly well.

According to propertyreporter.co.uk, searches for new-build homes saw an 8% rise between April and May, bucking trends in the wider market for UK house prices. Considering these figures, it’s not really surprising to see the UK’s biggest housebuilders reporting strong trading figures.

This week, Crest Nicholson (LSE: CRST) and Bellway (LSE: BWY) have both told the market that they are outperforming expectations.

Bellway saw a 5.9% year-on-year increase in sales reservations for the four months to the start of June. As sales have pushed higher, the group’s forward order book has continued to expand. It now stands at £2.4bn, up 27.3% compared to the same period last year. It expects to complete 10% more homes this year, although the average selling price of new homes is seen falling back to £305,000 from £306,500.

Crest Nicholson’s completions rose 7.8% during the six months to the end of April while the number of forward sales at the end of the period totalled 2,891 units, compared to 2,771 a year ago.

In some ways, it’s not really surprising that consumers are still snapping up new homes as the rest of the market cools. Around a third of the owner-occupied homes in England were built before 1919. The majority of properties were constructed before 1980.

Not only did the pandemic change what people want from their homes, (i.e. more space) but rising energy costs and sustainability credentials are now at the forefront of buyers’ minds.

Older properties are far less energy efficient than newer homers and can cost a lot to bring up to standard. That’s if owners can bring them up to standard. Installing heat pumps and electric car chargers in some older properties might be nigh on impossible. Newer homes might cost more upfront, but with the ability to choose interiors, more space and lower running costs, they could be a better deal in the long run.

The opportunity for investors

The average age of the UK housing stock, coupled with the structural undersupply in the market, suggests that even with credit conditions tightening for buyers, builders and developers might be able to escape some of the pain of a potential downturn in UK house prices.

Moreover, builders can offer incentives to buyers if the market turns.

For example, a company such as Bellway, with its £160m of net cash, could afford to pay the stamp duty costs for buyers. Bellway is projecting an underlying operating margin of 18.5% this year, implying a margin of £56,425 on an average selling price of £305,000. With an average stamp duty charge of £5,250 due on this value, the group could afford to cover the cost without even digging into its cash reserves.

Of course, there is no guarantee demand for new homes will hold up in the face of the economic storm gripping the UK. Still, it does seem as if builders and developers are in a far better position to deal with uncertainty than other players in the housing market.

However, most of these market’s home builders are on deeply depressed valuations. Based on Refinitiv analyst estimates Crest Nicholson is trading on a forward price/earnings (p/e) ratio of 6.5. With sales locked in for the next year, the company has a high level of visibility over these earnings. It is also set to offer a 6.2% yield. Bellway is selling at a forward p/e of 5.4 and yields 6.2%.

Elsewhere Barratt Developments (LSE: BDEV) is selling on a forward p/e multiple of 5.9 and yields 8.1%. Taylor Wimpey (LSE: TW) is trading on a p/e ratio of 6.4 while yielding 8% and Vistry (LSE: VTY) offers a yield of 8.4%.

Buying a basket of these stocks could be the best way for investors to play the growth of the sector and pocket a high single-digit dividend yield at the same time.