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Are UK housebuilder shares a sound investment?

Brexit uncertainty adversely affected UK property shares in 2018. Photo: Daniel Leal-Olivas/AFP/Getty

Both the bottom line share price of major house builders have performed well in Britain over the past few years for several reasons.

There’s a housing shortage across much of the UK, which has driven up property prices in the worst affected areas and created profitable opportunities for developers.

Though there is an affordability problem for many aspiring first-time buyers, demand for house purchases is supported by low interest rates and schemes such as help to buy.

There were 367,038 first-time buyers who secured mortgages in 2018, according to analysis by Yorkshire Building Society, the highest number in 11 years.

And while tight planning rules help keep land prices high, increasing the cost of development, the government has relaxed the law in recent years to fuel more construction work.

According to a House of Commons briefing paper published at the end of 2018, England alone needs to build between 240,000 and 350,000 new homes a year to meet demand.

In the 2017/18 year, the English housing stock increased by just 222,000, a 2% annual increase. There is plenty of room in the market for developers to increase their output.

But after significant share price gains in recent years, the wheels came off some of the biggest construction players during 2018 as fears over Brexit heated up.

A chaotic or hard Brexit would threaten the housing market. A potential economic slowdown, or even a crisis, and higher interest rates would hobble demand for home purchases.

The recent and sharp falls in property prices across inner London have also hit developers with projects still ongoing in the city.

As a consequence, several of the biggest homebuilders saw their share prices drop by a double-digit percentage in 2018, the sector’s worst year since the financial crisis.

However, this year could be a different story. Though Brexit is plunging the UK into a political crisis, it looks as though there could be a lengthy delay to the process.

There is also the prospect of a second referendum. And if Brexit does still happen, it is looking like it will be a so-called “soft” version, minimising the impact on the economy.

With Brexit fears easing slightly, and the fundamental problem of a lack of supply in the housing market as acute as ever, house builder shares are on the up again.

Berenberg said in an analysts note sent in March that UK house builders had a decent start to the year and tipped Barratt Developments, Bovis, Bellway, and Taylor Wimpey.

Taylor Wimpey (TW.L) shares are up 34% over the year to date. Barratt Developments (BDEV.L) shares are up 33% over the same period. Bovis (BVS.L) is up 27% and Bellway (BWY.L) 23%.

The bank predicted that the residential construction sector would over the next three years return 22% of its market capitalisation through dividends and share buybacks, a tempting prospect for investors.

Tony Williams, head of the building and construction team at Hardman & Co, wrote in a report in January that the house building industry is "wiser, ungeared and better managed" since the financial crash.

As an example, the analyst highlighted that only one of the six companies to report results in the fourth quarter had any net debt at all, with Berkeley (BKG.L) sitting on £860m of net cash, up on £633 in 2017.

"At the same time, munificent dividends are being paid, with a number of double-digit yields available," Williams wrote.

He used Berkeley as an example of what looks to be the sector’s turning fortunes at the close of the year after the firm gave guidance on a 25% fall in pre-tax profit in the year to 30 April 2019.

"Yes, a lot of red ink was spilled in 2018,” Williams wrote of Berkeley. “But, December (+1%) turned (the only 4Q month to rise), as did the nine-day Christmas holiday trading period (+2.2%) together with the opening four trading days of 2019 (3.2%); and (including Berkeley) the consensus view on sector earnings is flat this year but, already, at +5% in 2020.

"In a yield-hungry world, too, check out 7% plus available on an average sector dividend."

As Williams summed it up: "Ian Dury once said: 'all I want for my birthday is another birthday'; and the industry will have one too."