Anyone looking at the share prices of Britain’s major housebuilders this year could easily feel seasick. As in the past, any perceived change in consumer sentiment hit them hard. The Brexit vote was no exception.
But the stockmarket tends to overreact and that, surprisingly, helps rational, long-term investors.
Trading conditions for large housebuilders are favourable. Competition for land is relatively low. The number of small and medium-sized builders has plunged since the 1980s and continues to do so – the number of builders producing fewer than 30 homes per year has halved since 2007, from 5,000 to 2,500.
We have a favourable political backdrop: building more homes is a priority for this government and it is hard to see how future governments won’t take the same view. Government has been selling underused land such as redundant Ministry of Defence bases that could be better used for housing. The Help to Buy scheme improves affordability for first-time buyers and those with limited savings. The mortgage market is competitive and the cost of home ownership with a mortgage is, for many, attractive compared to renting. Large housebuilders are able to navigate the complex planning system. They make a major contribution to the economy by bringing on apprentices and graduates who then go on to join the wider construction industry. And there is still a woeful undersupply of homes. The UK needs to build 250,000 to 300,000 houses per year and we are not even close to that number.
In our base-case scenario, several of the quoted housebuilders are worth twice their current share prices. Barratt and Bellway are good examples and companies in which we are invested.
We also carefully consider the downside. Housebuilders score highly here too. Barratt, for example, spends more than £1bn per year on land and has £4bn of capital on its balance sheet. The raw assets alone are worth £4 per share (Barratt is trading at £5) and in an orderly liquidation (building and selling houses on every plot of land it owns today, but not buying any more land) the firm is worth £6 to £7 a share.
We like to buy businesses that are slow-moving, predictable and easy to follow. Housebuilders are all three. We then carefully monitor what we have bought. This means meeting executive management, meeting land buyers, mystery shopping, visiting sites, tracking usage of the firm’s websites and reading the trade press. Investors can learn much by putting themselves in the shoes of customers and competitors. Doing this helps us to build an understanding of the nuts and bolts of a business and also gives us an early warning of something going wrong.
And you need a thick skin. Share prices lurching down – Bellway’s plunged by 38% in late June – may not be comfortable but it does give you a chance to buy an asset at far below its real value. If an overcoat was reduced by 38% in a sale it may spur you to make that purchase. It is strange that investments are seldom seen that way, with the shares instead seeming more attractive the pricier they become. Share price volatility is not risk, it is in fact opportunity.
Successful investors tend to be dispassionate. This means tuning down emotions and resisting the natural tendency to be over-influenced by personal experience. The investing community and the media are based in London and the South East. They will be influenced by what they see and hear around them and so we end up with a South- Eastern slant on the housebuilding market. What happens to the London prime property market is not necessarily representative of what is happening across the country.
Investing in housebuilders needs a rethink. Instead of looking back on the times when overborrowed housebuilders went into recession and then faced sobering reality, investors should instead assess the landscape as it exists at the present, including the strong financial health of the companies involved. In the meantime, for the rest of us this current bearish attitude is what gives us the opportunity and explains, in part, why housebuilders now make up a third of our investments.
Tristan Chapple is a director at Aurora Investment Trust
