As a group, UK housebuilders have produced astonishingly good financial results over the last decade.
This has given their shareholders equally astonishing returns, with average share price gains from the largest housebuilders at close to 1,000% since the 2009 financial crisis.
One housebuilder in particular, Bellway, sits at the very top of my stock screen, thanks to its impressively consistent double digit growth, high profitability, low debts and a dividend yield of around 4% (at a share price of 3,800p).
And following the Conservative’s win in the 2019 general election, Bellway’s share priced jumped another 10% or so, rewarding shareholders with yet more capital gains.
So are housebuilders set to produce similarly impressive returns over the next decade, or has this particular house party already run its course?
I’ll try to answer that by first looking at the financial results which underpin those impressive share price gains.
Bellway’s financial results are astonishingly good
I’m going to stick with Bellway as it’s one of the better housebuilders in my opinion. Here’s a quick chart showing its quite frankly amazing results over the last decade:
As you can see, everything that’s good (revenues, earnings, dividends etc) has gone up over the last decade, by a lot. For example, its:
- Growth Rate (averaged across revenues, capital employed and dividends) has averaged 23% per year.
- Growth Quality (consistency of growth across revenues, earnings and dividends) has been 100%, i.e. everything went up every year.
- Profitability (averaged across return on sales and return on capital) averaged 15% per year.
- Debt to earnings ratio is very low as Bellway has almost no debt.
These are incredible results and, on top of that, the company has no large pension liabilities and hasn’t made any large or risky acquisitions in recent years.
These are exactly the sort of financial results I like to see in a company, so I think Bellway is definitely worth looking at in more detail.
People will always need houses
Bellway’s core business is housebuilding which means, unsurprisingly, it builds houses.
It does this in the UK, with a fairly even split between houses built in the north and south (split about 48% to 52%, respectively).
It builds mostly for the private market (88%), with a small amount for the social housing market (12%).
Revenues, earnings and dividends have grown enormously over the last decade, primarily because Bellway has built more houses and sold them at higher prices:
- The number of houses sold by Bellway has more than doubled from 4,595 in 2010 to 10,892 in 2019 (a 137% increase)
- The average price of each house sold has almost doubled from £167,000 in 2010 to £295,000 in 2019 (a 76% increase)
- The average net profit per house sold has increased sixfold from £8,000 in 2010 to £49,000 in 2019 (a 533% increase)
These are fantastically good results for a relatively mature company operating in a very mature market. Some might say too good, so let’s look at some negative factors.
The housing market is cyclical
Houses are capital goods, which means they’re expected to last many years, unlike short-lived products like toothpaste or food. Once you buy a house, you won’t necessarily need to buy another one, ever.
This makes it very easy for people to not buy houses if they’re worried about their job, their spouses job, or the economy in general.
If people are reluctant to buy a house then forced sellers (e.g. those who can’t afford their mortgage or those who need a large cash lump sum) will have to lower their asking price and this can have a significant impact on overall house prices.
For example, at the peak of the previous housing cycle in 2007, Bellway sold 7,638 homes. At the nadir of that cycle, in 2009, Bellway sold 4,380 homes.
That’s a decline of 43%, which is a lot by almost any reasonable standard. This was compounded by a decline in the average selling price, from £177,000 in 2007 to £156,000 in 2009.
And since Bellway’s was unable to reduce its expenses in line with its revenues, the 2007-2009 decline in house prices and homes sold caused profits to decline from £167 million in 2007 to a loss of £28 million in 2009.
That should give you a very clear picture of what can happen to highly cyclical companies (even high quality ones) during a cyclical downturn.
However, a company isn’t uninvestable just because it’s highly cyclical (at least I don’t think it is). But it does mean we should probably try to work out how much of its recent performance (good or bad) is down to where we are in the cycle, and how much is down to the company’s underlying strengths (or lack thereof).
Is the housing cycle largely responsible for Bellway’s results (and those of other housebuilders)?
If we compare Bellway’s results from the current cycle (approximately 2010-2019, so far) to a similar period from the previous cycle (approximately 2000-2009 for the sake of simplicity) then we can see how much it’s grown from one cycle to the next, rather than how much it’s grown within a single cycle.
Here are the raw numbers. Bellway’s:
- Average revenue per share went from 864p (2000-2009) to 1,466p (2010-2019), an increase of 70% or 5% per year annualised.
- Average earnings per share went from 84p (2000-2009) to 217p (2010-2019), an increase of 158% or 10% per year annualised.
- Average dividends per share went from 23p (2000-2009) to 72p (2010-2019), an increase of 216% or 12% per year annualised.
So Bellway’s average annual growth, from one cycle to the next, has been about 9%. That’s still very good, but it’s 14% short of the 23% growth rate achieved from the beginning of this current cycle.
Very simplistically then, we could make a ballpark guess that Bellway is responsible for 9% of its recent annual growth rate, while the housing cycle is responsible for the remaining 14% (this is more about providing context than the specific numbers).
If I’m right that the housing market cycle is mostly responsible for Bellway’s impressive recent results, then other housebuilders should also have impressive results, regardless of the underlying quality of their businesses (because a rising tide lifts all boats, good, bad or ugly).
And consistently spectacular results over the last decade is exactly what we see among the UK’s largest housebuilders:
|Housebuilder||10-year revenue growth to 2019|
All of these mature companies, operating in a very mature market, have grown revenues by more than 100% over the last ten years. Either these are some of the best companies in the world, run by some of the greatest business minds to have ever lived, or…
…these companies are riding a cyclical boom and just happen to be in the right place at the right time (Nasim Taleb would probably call them “lucky idiots“).
I know which I think is more likely.
My next question then, is this: Can Bellway consistently grow by about 9% per year from one cycle to the next, or is that cycle-to-cycle growth just down to the size of the current housing boom relative to the previous boom? In other words:
Are housebuilders simply riding the mother of all housing booms?
To answer that, let’s take a walk through some recent UK housing market history.
First of all, you don’t have to be a property investor to know that the UK went through a massive housing boom during the 2000s.
In the run up to the 2009 financial crisis, banks were handing out money to pretty much anyone that had a pulse. In some cases, they would lend up to 125% of the value of a house, completely removing the need for any sort of deposit and effectively putting the buyer into negative equity from day one.
Of course, that all came to an end with the credit crunch, when the obvious unsustainability of those loans finally turned around and bit the banks (and the taxpayer) on the backside.
But anyone who expected UK house prices to decline from seven-times earnings in 2008 to their historic average of about four-times earnings was sorely disappointed.
Yes, after the credit crunch house prices did decline, from £177,000 to £156,000 in Bellway’s case. And banks did tighten up their lending criteria, which dried up demand as most potential first time buyers in 2009/2010 had no chance of raising a 10% deposit on a £150,000 starter house.
But after the crisis, a combination of record low interest rates and a flawed planning system were more than enough reverse the short-lived price decline by fuelling demand and constraining supply.
This combination was so effective that by 2011 Bellway’s average selling price had surged to £180,000. That’s higher than at the peak of what was then the biggest property bubble in history, and just a couple of years after the near-collapse of the global financial system.
So against all the odds, UK property prices didn’t mean revert back to normal levels after 2009. Instead, a new housing bull market began from already very elevated house price to earnings multiples.
At first the new housing bull market began quite slowly, with Bellway’s average selling price increasing by about 6% per year between 2010 and 2013, and the number of new homes built going up at about the same rate.
But then something odd happened.
New build house prices jumped by 10% in 2014, 5% in 2015 and then a massive 13% in 2016. After that initial price explosion, new build prices have increased at a more pedestrian pace, but still enough to leave Bellway’s average selling price at just shy of £300,000 today.
That’s almost double the price of a new build house at the peak of the 2000-2009 housing bubble.
Along with this sudden jump in house prices came a sudden jump the number of houses sold. Before 2014, Bellway was increasing its number of homes sold by about 6% per year, but in 2014 it sold 21% more homes than in 2013. 2015 and 2016 also saw double digit increases, although as with prices, that has slowed to low single digit growth over the last couple of years.
Thanks to that explosion of new build house prices and homes sold, Bellway now sells twice as many homes as it did a decade ago and at almost twice the price.
This has increased the company’s return on sales (profit margin) to almost 17%, which is about twice the average return on sales it generated through the housing boom of the 2000s.
And with Bellway’s surging revenues and profit margins come surging profits, from £40 million a decade ago to more than £500 million today.
Now, I don’t profess to be an expert in property market cycles, but this certainly doesn’t look like a normal cycle to me (and neither did the last one, come to think of it).
Given that the last UK property bubble ended with the highest property valuation ratios in history, it seems inconceivable to me that UK house prices can continue to double every ten years or so, especially when the earnings that pay for those houses are not increasing even half as quickly.
So although Bellway has grown by about 9% per year from one point in the last cycle to a similar point in this cycle, I think much (most?) of that is due to the incredible scale of the current housing boom, even when compared to what was previously the largest housing bubble in history.
However, before I dismiss the success of Bellway and other housebuilders as simply the result of a housing bubble built on top of the previous bubble, it would be useful to know what caused this huge housing boom in the first place.
Because if we understand what caused the current boom, we might understand what will end it as well.
Help to Buy: It looks a lot like a government sponsored ponzi scheme
It may come as no surprise that Help to Buy is a key driver (in my opinion) of the current house price bubble.
Help to Buy is, in simple terms, a government scheme to help first time buyers buy new build houses (in practice there are many nuances and loopholes which are not super relevant to this article).
The flagship Help to Buy Equity Loan scheme:
- loans first time buyers 20% of the price of the property
- charges no interest for the first five years
- charges 1.75% interest after five years, increasing by RPI + 1% (so if RPI was 4% then the 1.75% would increase by 5% each year to reach 2.23% after five increases, and continue upwards from there)
- is an equity loan, so if the house is subsequently sold for more than the purchase price, the owner owes the government 20% of that increased price (i.e. more than they borrowed, and less if house prices go down).
This of course means that first time buyers can (at least during the first five interest-free years) afford to pay 20% more for a house than before (or if they could already afford it then Help to Buy makes it even more affordable by reducing their borrowing costs).
Help to Buy also means that banks are willing to lend to first time buyers who can only raise a 5% deposit, because the government is providing an additional 20% equity buffer.
And finally, not only will banks lend to Help to Buy buyers with mere 5% deposits, but because of the government’s 20% equity stake, banks only have to lend up to 75% of the value of the house, which means lower interest rates for those eligible for Help to Buy as well.
Somewhat unsurprisingly, this has led to an increase in the price of new build properties, to the point where Bellway’s average selling price is now 50% higher than when Help to Buy was first launched (about 30% to 40% of Bellway’s homes are sold through the Help to Buy scheme).
Also somewhat unsurprisingly, Help to Buy funding has flowed straight from the taxpayers’ pocket, through the fingers of first time buyers and into the pockets of Bellway and the other large UK housebuilders.
I say “unsurprisingly” because anyone with even the slightest interest in the interaction between supply, demand and prices would have seen this coming a mile off. For example:
- Government is not the solution to the housing crisis (PDF)
- Outrage as help-to-buy boosts Persimmon profits to £1bn
- The paradox of modern housing policy
- Help to buy has mostly helped housebuilders’ boost profits
- Here’s why Help to Buy was a terrible idea
- UK housing market is a bubble with Help to Buy pushing up prices
So Help to Buy has been an incredible windfall for UK housebuilders, but their current record levels of revenues, profits and dividends depend almost entirely on continued government interference in the supply and demand side of the housing market, and that’s a very risky position to be in.
When Help to Buy ends, what will happen to house prices?
Help to Buy is set to end in 2023, unless the government decides to double down on this unsustainable policy and extend it even further.
Let’s assume for now that Help to Buy does end in 2023. Then what?
Well, Bellway sells about 30% to 40% of its homes through the Help to Buy scheme, and others such as Persimmon rely on Help to Buy to shift around 50% of their stock. So clearly there will be a material impact on these companies when the scheme ends.
And given how high UK house prices are relative to earnings, I think there could be a lot of downward pressure on prices once Help to Buy is killed off.
I think likely impacts could include:
- Lower new build house prices: Without Help to Buy, buyers will have less funds available to buy houses.
- Higher deposit requirements: Without Help to Buy, banks could demand higher deposits to offset the increased risk of negative equity.
- Higher mortgage interest rates: Without Help to Buy, banks could demand higher interest rates to offset the increased risk of negative equity.
- Fewer new builds: I think the headwind of higher deposits and higher interest rates will more than offset the tailwind of lower house prices, leading to less demand and therefore less new builds.
Exactly what this would mean for Bellway and other UK housebuilders is impossible to know in detail, but I think they could end up selling significantly fewer homes at significantly lower prices, and that would have a dramatic impact on their results.
For example, if Bellway’s profit margins reverted back to their historic average of 9% from their current Help to Buy inflated 17%, that alone would virtually halve the company’s earnings, which would put pressure on the dividend. And that’s without factoring in lower revenues from selling fewer homes and at lower prices.
In summary then, I think it’s reasonable to describe the current house price boom as a government fuelled house price bubble, and that record housebuilder revenues and profits are largely dependent on Help to Buy.
So although it’s impossible to know how the cycle will evolve form here, one thing I don’t want to do is invest in a highly cyclical housebuilder somewhere near the peak of the largest UK house price boom in history (one that’s so big and unstable it needs explicit government support to stop it from imploding).
A target price for Bellway
Despite all the negative factors facing UK house builders, I actually quite like Bellway. It was, after all, the only large UK housebuilder to continue to pay a dividend through the financial crisis.
Its margins and returns on capital through both of the last cycles are also quite good, averaging about 10% and 12% respectively. And it currently has no debt, which is very sensible for such a highly cyclical company.
But despite Bellway’s reasonably attractive 4% dividend yield (at a share price of 3,800p), I still think the price is far too high given where we are in the housing cycle (possibly somewhere near the top; almost certainly nowhere near the middle or the bottom).
My preference with highly cyclical companies is to buy them somewhere near the bottom of the cycle rather than somewhere near the top. In Bellway’s case, the last market bottom occurred around 2009.
Back then, when many investors thought the UK housing bubble would burst catastrophically, Bellway’s share price was below 500p. That gave the company the following valuation ratios:
- PE10 (price to 10-year average earnings) of 6.0
- PD10 (price to 10-year average dividend) of 21.8
These multiples just about meet my valuation rule for buying highly cyclical companies:
- Investment rule of thumb: Only invest in highly cyclical companies when their PE10 and PD10 ratios are below 10 and 20 respectively
That valuation rule is very demanding and 90% of the time even highly cyclical companies won’t be anywhere near that cheap. But sometimes they are, and that sometimes almost always occurs near the bottom of their market cycle, which is almost always the best time to buy highly cyclical companies.
For Bellway to hit those valuation benchmarks in the current cycle, its share price would have to fall below 2200p, in other words:
- My target purchase price for Bellway is 2200p or less
That would require a decline of about 35% from the current share price, which really isn’t all that much in the grand scheme of things.
But even if its price did fall below my target, I still probably wouldn’t buy until the current housing bubble popped, or significantly deflated at the very least.
For now then, I’m happy to sit back and watch Bellway with detached interest, but not to buy.
As for the other UK housebuilders, I think we’re far too late in the mother of all housing booms for any housebuilder valuation to be attractive, and I think new build house prices are massively overblown thanks to a series of badly thought through government interventions.
Of course, if you’re a cynic and think the government’s intention all along was to inflate the housing market, then Help to Buy was a stroke of pure genius which will probably be extended far beyond 2023, in which case UK homebuilders could still represent excellent value.
Nice Article, I would like to know what would be the best way for British expats living in North America to get involved or invest in the UK stock market. Right now the only way I see is to invest through ETFs. Are there any better Tax efficient ways to invest in the UK market. Thank you.
Hi John, another good article. When HTB was introduced I wondered how do you then end it, so I haven’t been surprised by the extensions. Perhaps criticism of the scheme will see time called on 2023, but this is just one year before the next election, so I wouldn’t be surprised to see it extended beyond the election.
John Kingham says
I agree, HTB may be with us for a good few years yet, but the longer it stays the worse the eventual correction is likely to be, in my opinion.
John Kingham says
I’m not sure about tax efficiency, but you can certainly buy UK stocks from the US, e.g.
Kodiak and Grizzly Bears says
You may acquire all these stocks on the London Stock Market. You need a broker though.
Anthony Marsh says
Having been a UK expat living in North America you can still buy U.K. stocks – you just need to find a local brokerage that provides access. I recommend Interactive Brokers – low fees (as long as you meet their minimums). I concur that living as a British expat in the US brings with it a whole host of hoops to jump through in order to get access to your “home” market – with the added complexity of US tax reporting regulations (which is why many U.K. companies do not want to go near you).
MICHAEL HARDWICKE says
I too am an Expat (Malaysia) and I hold a portfolio of FTSE Divi stocks held in the UK (AJ BELL Platform). Surely, as an expat, you are exempt any tax liabilities as long as you do not realise any profits whilst abroad? (Am I missing the point?).
Michael Robbins says
My mother (expat) uses TD (now called internaxx) based out of Lux. There is a quarterly fee and trades cost double the standard. Service good so far.
Steve Kirk says
Thanks Jon, always interesting and valuable to read your analysis.
As a long time holder of Persimmon and Bovis shares, I have to be grateful as they have supported my portfolio through tough times and with the ongoing Bovis/Galliford Try tie-up plus a progressive dividend policy at Persimmon there’s more excitement to come.
To be prudent and to recognise that all cycles come to an end eventually, I’m taking profits on regular basis so they don’t dominate my portfolio but I think there is another 1-2 years of growth and good news ahead.
John Kingham says
I think you’re probably right that there could be a few years left in this housing boom, but as a value investor the house price to earnings ratios are telling me the downside risks are huge, so I’ll just have to miss out on any remaining “excitement” !
John, thank you for your analysis of the home builders. So far I have invested in Berkeley and I will choose one more from this sector, maybe Taylor Wimpey (the FCF of Bellway concerns me).
John Kingham says
Hi Ken, good luck. Feel free to remind me of my negative stance if your housebuilder shares continue to do well!
I fear that without the Tax payer funded help to buy scheme, results would have looked very different, as they will when it is finally withdrawn.
If you track the share prices of the builders from te day HTB was introduced, you will see the direct correlation.
Artificially deleveraging the builder by 20% was like writing a blank cheque – as the CEO for Persimmon found to his delight and greed.
Perhaps the new title might read — is it too late to sell?
I guess the answer probably not.
John Kingham says
Hi LR, it’s interesting to sit back and watch the housing insanity play out, how long valuations can stay at extreme levels and how far a government will go to prop up a market when doing so is to its short-term political advantage.
Hopefully I’ll live long enough to see this housing mega-cycle (1995 to 2020 so far) play out in full.
Chris Brown says
The government has an obvious interest in propping up house prices. Help to buy may never end.
John Kingham says
Hi Chris, I think you could well be right, although forever is a very long time.
The problem is that prices will adjust to accommodate the extra 20% subsidy, which mean that eventually 20% won’t be enough (we’re probably reaching that point already).
So then what? A 30% subsidy, 40%, 50%? In the end, any subsidy will just push up prices unless supply increases sufficiently, and if prices go up then more subsidy is required.
This is clearly sustainable and at some point supply is likely to pick up when the average age of a first time buyer is say 40+, because older people vote more and when older people are still waiting to get on the housing ladder, they’ll probably vote for whichever party promises to (and delivers on) massive increases in housing supply.
That’s one theory anyway.
The Conservative government is very aware that it needs to get young people onside to stay in power.
I very much doubt that they will discontinue help to buy in 2023.
Like low interest rates very easy to introduce very hard to withdraw.
The key driver of a companies success within a cyclical industry is capital allocation. I think if management are able to consistently deliver ROE which is higher than industry average then its worth considering to invest in.
Unfortunately in cyclical industry management follow the same lack of caution as investors do within a bull market. This is why generally speaking its actually quite difficult to find a worthwhile investment during a buoyant market.
John Kingham says
Hi Reg, another complicating factor with housebuilders is that the price of the underlying product (houses) moves around so much. In most companies it’s more to do with a change in volumes, e.g. a toy company that has a hit toy, but with housebuilders the boom can be in terms of house prices as well as new build volumes.
This makes it doubly difficult to estimate how well their land bank (i.e. their main capital asset) will perform over the next five or ten years.
I think to a certain extent the only way to succeed is have a good knowledge of the local markets the house builder operate in. One can use websites like right move, ONS and zoopla to become well versed of the local markets.
The only downside is the time it will take to do all this research. I think to me it makes more sense to focus on a quality company which you can potentially hold for many decades rather than on a cigar butt.
Irrespective of the valuation house builders can never really be classified as a quality company because their performance swings with the flow of the economic tides. For this reason I would never invest in a listed property company. Although I do think investing in property is a great vehicle for wealth accumulation on an individual basis.
Bob Barnacle says
Dropped GLE today, but still hanging on to CRST and PSN, with both seemingly out of favour.
Is the analysis being too heavily influenced by the recession following the financial crisis in 2007?
There was a recession of the same length (but not as deep) from Q3 1990 which didn’t have as big an effect and although my share price data only starts in July 1988, 5 year share price performances start at 85% in July 93 and then just gets higher until July 1998 when it starts to decrease with an average of 107% per 5 year period up until July 2008.
It’s only July 2008 where the 5 year (historical) SP performance turns negative.
The data I use doesn’t include dividends either.
It would be nice to see how well BWY have performed during earlier times too. Just 2 recessions isn’t a big enough sample and I certainly don’t think we should base our analysis on just one.
Most of this incredible SP performance prior to “Help to Buy” too.
The same argument, that we are near the end of the cycle could have applied at the start of 2019 but with BWY showing a 52% SP gain in this calendar year (again, not counting dividends) it is a brave man who guesses the end of the cycle in order to buy in at a discount.
John Kingham says
It’s a valid point. One cycle is not enough to base a decision on, so I looked back to about 2000 for the article, which is effectively two mini-cycles (2000 to 2009 and 2009 to 2019).
For what it’s worth I think we’ve had one mega-cycle since about 1994, which was the last time housing in the UK was cheap by historic standards (following the late 80’s housing crash). Then we had a recovery to 2003, then interest rates were cut in the wake of 9/11 so we had a bubble to 2009, then the government threw the kitchen sink at housing to stop the bubble bursting, with zero interest rates and help to buy.
But back to your point about looking further back. It’s a good idea, but the problem with looking back decades is that the earlier data is decades old and, possibly, has little to do with the company’s performance over the next decade, which is the one that matters to investors today. So there’s always a trade off between getting more data and more insights, which is good, and that older data being potentially irrelevant or misleading, which is not so good.
Personally I pay a lot of attention to the last decade, some attention to the decade before that, and very little to anything more than 20 years ago.
If you look further back at Bellway you’ll see that it’s grown very rapidly over a long period of time, but that doesn’t change the fact that its recent results are largely a result of super low interest rates and government subsidies like Help to Buy.
I agree that the same argument has applied for years and that would mean missing out on huge gains in the short-term, but I have zero skill in navigating short-term share price movements so I’m happy to miss out if the fundamentals don’t match what I’m looking for (i.e. good long-term investments).
I think the best way to buy these cyclical companies at a discount is to be super-strict on the valuation side, which for me means PE10 below 10 and PD10 below 20. If Bellway hits those levels then I might take a look, but I would probably wait for Help to Buy to end first to see how it does without government support.
What about REITs would love to see an article about those. Thanks!
John Kingham says
Sorry but I don’t review funds or investment trusts. You might want to try whichinvestmenttrust.com
With Bellway recently falling below your target price of 2200p I’d be interested to know whether you have pulled the trigger.
The current dichotomy of rising house prices and falling housebuilders suggests the markets are assuming this is the blow of top for house prices.
I’m not so sure.
John Kingham says
Hi Adam, no I haven’t invested in Bellway yet. There are a couple of reasons, one specific to me and one more general.
In my case, I’m not really looking to add a highly cyclical company to my portfolio at the moment. I think my portfolio is a little light on defensive companies so I’m trying to lean in that direction at the moment, although their valuations aren’t great because they’re popular for obvious reasons.
More generally, I don’t like the UK housing market as it’s been massively distorted by government intervention both in terms of limiting supply (crazy planning rules) and fuelling demand (Help to Buy, LISA etc).
These distortions may (hopefully) unwind over the next decade as the new building regulations come into play (probably allowing more houses to be built by smaller housebuilders) and as COVID-19 debts leaves the government unable to afford the cost of subsidising home purchases to buy votes.
But, like you, I’m not sure, so it’s not a market I want to invest in unless I can buy in a ultra-low levels, which a back of the envelope calculation says might be 1500p or so.