Important information: The value of investments and the income from them, can go down as well as up, so you may get back less than you invest.

THE UK market is awash with housebuilders which offer sizeable dividends and well-established business models. There’s much here to like, but keep your wits about you. Housing is a cyclical market, and the fortunes of housebuilders can vary between good times and bad.

Here’s all you need to know about investing in UK housebuilders.

A cyclical market

Record low interest rates and surging demand for UK housing after the financial crisis have resulted in a decade of sharply rising house prices. That’s been good news for the UK’s housebuilders - greater demand means they’re able to sell the land they develop at higher prices.

At the same time, the market has become more concentrated, meaning fewer housebuilders now own a greater share of the pie. Those that remain have used the time since the financial crisis to shore up their businesses, reducing costs and raising capital. That’s left an historically debt-laden industry in a far stronger position.

So far, so good. But there’s a flipside. Things can change quickly in a cyclical market like this.

We expect houses to last for years and we mainly think about buying a new one when our circumstances change, not because the old one is falling apart. This makes it more common for people to delay these purchases in times of broader economic stress or job insecurity - why add another risk into the equation?

If buyers dry up, forced sellers can often see no other option than to lower their asking prices.

This all means that the fortunes of housebuilders are tightly interwoven with those of the wider economy.

2020 captured that cyclicality best. After an initial, drastic fall in prices when the pandemic set in, the market staged a remarkable and sustained recovery. Prices rose 7.5% in 2020, the highest growth rate for six years.1

High risers

The market’s rebound is starting to leave an impression on companies’ balance sheets, and housebuilders have been handsomely rewarded: FTSE 100 constituents Persimmon, Barratt Developments and Berkeley Group all saw their share prices rise more than 60% over 2020. Please remember past performance is not a reliable indicator of future returns.

Fellow FTSE 100 name Taylor Wimpey is reaping the rewards of an ambitious strategy which saw it take advantage of lower prices and invest heavily in new plots over the second half of 2020.

The company recently announced that it had completed more than 7,300 houses in the first six months of 2021, a record performance. Operating profits for the period stood at £424 million, and full-year profit expectations had risen to £820 million.

Taylor Wimpey is probably right to be optimistic over the short term. It’s likely that prices will remain high as demand continues to exceed supply. An improving labour market and rising consumer confidence as we emerge from the pandemic will also help fend against any sudden price correction.

Longer term, however, things look more uncertain. Remember, this is a cyclical market, and we can expect a cooling of prices eventually. The removal of furlough and the return of stamp duty at the end of this month could shake consumer confidence across the spectrum. The question for stock pickers is which companies they feel are best suited to, and best equipped to handle, the post-pandemic future.

Castles made of sand?

A key driver of last year’s rebound was a so-called “race for space”, which saw wealthier city-workers jump on the opportunity to work more flexibly and emigrate to the country. Rural areas like Wales and the North West of England have seen house prices rise most.

This poses a challenge to Berkeley Group. Its homes are heavily skewed towards London and the South East, where house prices have risen most slowly.

However, other drivers could play into Berkeley’s hands. Government incentives, such as the outgoing Help To Buy scheme and the pandemic-inspired stamp duty “holiday” - a temporary cut to stamp duty originally on all properties costing up to £500,000, now reduced to £250,000 - were designed to keep the housing market healthy and offer younger and first-time buyers a step onto the ladder.

They may have backfired. Rather than providing a helping hand, the schemes have combined to push house prices even higher and further from the grasp of most people. The average rise in house prices over the past 12 months (more than £18,500)2 surpasses the maximum saving you could have made on the stamp duty holiday before it was tapered (£15,000) and far surpasses what you can save now (£2,500).

At the same time, the average house price for a first-time buyer rose 10% in 2020.

What happens next depends largely on the nature of our economic recovery.

If the market continues to skew to the upper-end of the price spectrum, Berkeley could be a prime beneficiary. Whereas the average selling price for most housebuilders hovers around the £200,000 - £300,000 mark, Berkeley’s lies just below £800,000.

But if things level out and the government’s new 95% mortgages prove successful in opening the market to younger buyers, it could be companies like Persimmon and Barratt sitting pretty.

Dividend darlings

One reason investors like housebuilders is their record of reliable and strong dividend payments. Though most cancelled payments amid the bonfire of dividend cuts last year, all the big FTSE names have since resumed.

Most housebuilders boast solid forward dividend yields ranging around 4-6%. That’s encouraging, but as ever with dividend yields, the raw number doesn’t tell the full story.

Given the cyclicality of the housing market, you want your housebuilder to have a strong enough cash flow to cover its dividend payments when things eventually start looking less rosy.

For the most part, the FTSE 100’s housebuilders look pretty well covered. One company, Persimmon, stands out for a particularly high dividend, a forecast 8%. That might set off alarm bells.

Like its FTSE counterparts, Persimmon doesn’t betray any obvious liquidity issues, yet its ability to cover its payments will ultimately come down to earnings growth soon making up for last year’s fall in profits. Given things look relatively secure in the market over the short term, investors may feel confident.

Here too, however, stock pickers should recognise that an investment in housebuilders means taking an implicit stake in the health of the wider economy. There’s much to like about the housebuilders, and most boast financial positions strong enough to appear attractive. But prepare for troughs along with the peaks.

Five year performance

(%) As at 31 Aug

2016-2017 2017-2018 2018-2019 2019-2020 2020-2021
Persimmon 54.7 -0.1 -12.8 39.8 24.5
Barratt Developments 35.3 -7.3 27.2 -11.7 42.0
Berkeley Group 46.1 -0.3 8.3 22.7 6.1
Taylor Wimpey 31.8 -9.7 -3.5 -13.9 52.7

Past performance is not a reliable indicator of future returns

Source: FE, total returns in GBP as at 31.8.21

Source:

1 - https://www.nationwidehousepriceindex.co.uk/reports/annual-house-price-growth-slows-for-first-time-in-six-months-as-end-of-stamp-duty-holiday-approaches

1https://www.halifax.co.uk/assets/pdf/july-2021-house-price-index.pdf

Important information: Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. When you are thinking about investing in shares, it’s generally a good idea to consider holding them alongside other investments in a diversified portfolio of assets. Investors should note that the views expressed may no longer be current and may have already been acted upon. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to a Fidelity adviser or an authorised financial adviser of your choice.

Share this article

Latest articles

Watch: Market News Update - 16 May 2022

In this week’s market update: another down week for shares; bond markets catc…


Tom Stevenson

Tom Stevenson

Fidelity International

Market news today - Contrarians sense a turning point

What’s driving your investments this week?


Tom Stevenson

Tom Stevenson

Fidelity International

How to turn a profit in the post-Covid market

A bigger state and rising inflation means it really may be different this time


Tom Stevenson

Tom Stevenson

Fidelity International