David Stevenson: Housebuilders are ruinous for the UK but great for your Sipp

This week I want investors to hold one thought in their mind – that what might be good for millions of private investors might actually be a terrible outcome for the rest of the population in the UK.

I would argue that if you care about ESG investing and especially the ‘S’ bit in ESG, social outcomes, then you should be turning most of your attention to the UK and the top six housebuilders.

While I am sure that the big guns in this industry have a legion of analysts internally trying to justify why their building policies tick various social and environmental outcomes, the rest of us should be taking a rather more cynical view.

Put simply, in my humble view the big six housebuilders miserably fail the most important ESG measure – whether their operational policies cause untold harm to the UK. Unfortunately, while I think the answer to this is a big fat ‘yes, they do cause real harm’, as investments they are unbeatable.

The backdrop to this is the consensus view that with the end of the stamp duty holiday we are due a housing market correction. My own view is that the market will probably cool down and then regain its vim at some point next year.

Why my cautious optimism? In simple terms, most of the structural factors favouring higher house prices are still in place and are unlikely to change any time soon. This is terrible news for younger people.

House prices will keep rising

Let’s start with the obvious driver: low interest rates. Sure, rates might rise in the next year or two, as worries about inflation spike and the economic recovery deepens, but ask yourself how likely is that we’ll see rates rise above 2% to 3%?

I’d wager that the odds of that happening are low, if not minuscule, if only because our government is hooked on cheap credit, along with the rest of us.

The next driver is the government’s absolutely appalling Help to Buy scheme which has been a massive impediment to any sensible housing market reform. This horribly misguided policy has helped a few already wealthy younger buyers and flattered the builders’ profit margins but in every other respect is a terrible prop, underpinning ever higher house prices.

The sooner this policy is dumped the better, but the brutal truth is that the grip of developers and housebuilders on the Conservative party and its coffers is rock solid. That’s great news for the housebuilders, but terrible news for the taxpayer.

The last driver is that the supply of new housing is still massively lagging behind the sustained rise in demand. I’m going to ignore the entirely vapid arguments advanced by some that there is no real shortfall and that’s all a mirage conjured up by ‘Yimbys’ (yes, in my back yard – pro-housing development types).

The most comprehensive put down for this argument comes from the economist Liam Halligan (pictured below) in his essential summer read Home Truths which I’ve just finished.

I thoroughly recommend you peruse this book over what remains of the summer. If you’re not incandescent with rage at our broken housing market after reading this brilliant book, then I’ll be amazed.

The property market is broken

The grim reality is that the major housebuilders working with the land agents and other developers have a stranglehold on the ‘private’ market for new homes and are intent on managing the increase in growth.

And that results in the dominance of the top tier of large-cap housebuilders. This has been made worse by the utterly woeful track record of new social housing starts which has dried up over the last few decades, to the shame of all governments. Dig around and the root cause of this, according to Halligan, is land.

‘Land accounts for 70% of the cost of a home bought on the open market and rising land costs were behind three-quarters of the increase in UK house prices between 1950 and 2012,’ he wrote.

And of course, some of the biggest owners of that scarce land are… you guessed it, the housebuilders. Again, here’s the killer point from Halligan: ‘Accessing land, then obtaining planning permission amounts to the most formidable barrier to entry for all but the largest, most powerful housebuilders. Even dominant builders end up paying very high prices for acreage. This results in them building low-quality homes that are expensive to buy. Large builders then exploit their local monopolies by drip-feeding homes onto the market to push prices even higher.’

Even the government now recognises that the large housebuilders are in effect landbanking, although the industry always denies this. It claims that the last review by Oliver Letwin argued that landbanking wasn’t a problem – a view that Letwin has subsequently recanted, declaring after the review that ‘we’ve made a fundamental mistake handing over to private builders the development of very large sites’.

The net effect of this shameful failure of public policy is obvious to anyone with children in their 20s and 30s. Whole swathes of the working population are locked out of owning a home by excessive prices.

If ESG-minded investors really care about social outcomes, then this direct outcome from the housebuilders’ business practices is appalling. It is fuelling political hostility to capitalism and private property ownership.

For that, I’d give the big housebuilders a big fat red negative for making millions of people’s lives a misery by restricting supply, by building sub-standard properties, and for having the cheek to foist leases on new houseowners and then upping those lease costs every few years.

The housebuilders smash the FTSE

But dear investor, what a wonderful business model! And one which I think won’t really change very much for the foreseeable future, if only because politicians don’t really have the guts to tackle the core challenges outlined by Halligan, who is more hopeful than I am, by the way.

The table below shows the share price returns from the leading housebuilders and I’ve also given some returns for successful, popular investment trusts widely used by private investors as a comparison. You’ll see that Scottish Mortgage has provided better returns compared to all the housebuilders, as has the S&P 500, by and large.

But these two benchmarks have ridden a decade-long tech boom, whereas, by contrast, housebuilders are boring and low tech – but what an amazing investment they’ve been. Over 25 years, for instance, the total return for owning Persimmon has been an astonishing 2,010% with Berkeley not far behind at 1,660%.

 The housebuilders have easily outpaced the FTSE All-Share

The next huge table below shows why what I’d class the ‘A list’ of housebuilders – Barratts, Bellway, Berkeley, Persimmon, Redrow, and Taylor Wimpey – might continue to represent a great investment. Forecast dividend yields are enviable across the sector at between 3-8% and dividend cover, the buffer of cash a company has to fund these payouts is robust.

Housebuilders pay attractive, well-covered dividends 

The housebuilders’ forecast price to earnings ratios are in the 10x to 15x range, similar to the wider market. Ebit (earnings before interest and tax) yields are also in the 5% to 10% range and in some cases the return on capital employed are truly astonishing for what is in fact a low-risk business.

Berkeley’s return on capital employed (ROCE), a metric of how good a company is at generating profits from the capital it employs, is at 13.5% and Persimmon is at 21.9%.

Valuations across the sector are not onerous 

Now, I’m not making any predictions about which of the six in the A-list might outperform or underperform in the next few years as they all have their own idiosyncrasies.

In terms of stockpicking, if you want an idea of who might do best, I’d suggest looking at which of the six are most widely held by the most successful value-oriented UK equity fund managers.

Nevertheless, I would suggest that the future looks bright for these housebuilders as a collective over the next decade. Meaningful government action to address their stranglehold is, in my opinion, unlikely to make it to the statute books.

No-one with any real power will attack their huge land portfolios and even the current attempts to introduce zonal-based planning regulations are running into intense resistance from home counties Conservative MPs, frightened by the shameless local activism of Liberal Democrats.

Interest rates will remain lower than the long-term average and demand for houses from new family formation and immigration is likely to continue unabated and the ability of local councils and social landlords to fill the gap will remain incredibly restrained. Yet demand from working families is likely to remain heightened.

That, to me, spells a bull market for housebuilders, making them the one sure-fire way of playing an aging society. More is the pity, then, that that outcome will be a disaster for the UK and its citizens. As I said at the beginning, sometimes the most successful investments we make have terrible outcomes for the country at large.

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