Dominic Jeff: Shaky foundation for recovery

the chancellor’s extension of help to buy is a boost for the builders, but the lift could be short term and there are risks in creating an artificial demand, writes Dominic Jeff

The government has introduced a number of initiatives to help revive a flagging housing market. Picture: Justin Spittle

CITY traders had been braced for a further deterioration in the market last week as the Crimea voted to join Russia. In the event a Sunday BBC TV show gave them an easy option on where to put their money.

George Osborne’s announcement on the Andrew Marr Show that he was about to extend his controversial Help to Buy scheme meant billions more pounds of public money would find their way to London’s listed house builders.

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Investors have already done very nicely out of the Chancellor’s largesse. As more buyers were given a helping hand into an already recovering housing market, share prices in the likes of Persimmon, Barratt and Taylor Wimpey have roughly doubled in the last 18 months as a variety of state schemes have been launched and bulked up to compensate for the crippled mortgage market.

By the end of the week, however, reality kicked in and builders were in retreat as brokers and economists warned of high valuations and the dangers of a new housing bubble. The large builders also face dangers from rising land and labour costs, and competition from smaller firms which were offered their own incentives in Wednesday’s Budget.

Josh Phipps, a trader at Accendo Markets, said: “House builders on Monday saw a short-term lift in their values, off the back of the Chancellor’s announcement that the Help to Buy scheme is being extended until 2020. Prices have cooled off since then as traders take quick profits.”

He said financial institutions have been tweaking their models, which now indicate potential gains on house builders of up to 20 per cent over the next 12 months – a direct result of the potential increased profits to be generated from the renewed demand for new homes as first-time buyers gain access to easy money.

But he added: “Osborne did make special mention of the UK government’s intent to avoid creating another bubble. A new committee is now in place to specifically safeguard the housing market. It’s a good measure. But easy money – creating an otherwise artificial boost in demand in an economy coming out of recovery – is not without risk.”

UK house prices have risen by as much as 10 per cent in the last year on some measures, although other surveys suggest a more modest figure. And everyone agrees that London is skewing the national data. The economic recovery is in full swing in the UK capital and legions of well-paid workers have been prepared to pay eye-watering prices to get a toe-hold on the housing ladder.

Elsewhere the evidence is mixed. Official figures published earlier this month by Registers of Scotland showed that prices rose by just 1.4 per cent in 2013, despite a double-digit jump in the number of transactions. And even within Scotland the market varied considerably: in booming Aberdeen, prices were up 6.8 per cent over the year, but Stirling showed a drop of 4.1 per cent.

There is less doubt that activity is gathering pace rapidly. The Council of Mortgage Lenders (CML) has just reported a 43 per cent year-on-year jump in gross mortgage lending for February, suggesting that even the catastrophic flooding in parts of England could not dampen housing market activity. In fact, the CML reported that it was the strongest February performance in gross mortgage lending since 2008.

And the council commented that first-time buyers “have benefited most from the government’s Help to Buy initiatives.”

The mortgage guarantee scheme is the second wave of Osborne’s Help to Buy initiative, and is available to almost all buyers and for all kinds of property, not just new build.

That part of the scheme is even more controversial, as critics say that it is pumping money into the system without doing anything to address the lack of supply. That part of the scheme has not so far been extended.

With the equity finance part of the scheme – aimed exclusively at new builds – the theory is that the increased supply will help to keep the house market in check in the longer term. Nevertheless, most analysts have pencilled in strong house price rises for this year at least.

Bank of England governor Mark Carney has expressed concern about the UK’s past record of house booms and busts, although he is thought to be reluctant to use interest rates as a tool for tackling house prices. Instead, he might recommend to the government that it dilutes the Help to Buy mortgage guarantee scheme. The fact that interest rates are expected to start lifting off their record lows next year is, however, one of the concerns for those investing in house builders, as mortgages become less attractive relative to renting and recent buyers face higher payments that could potentially trap them in their existing homes and stop them moving up the ladder.

Stephen Williams, director of Brewin Dolphin’s equity research division, says that investors also need to be wary because an overheating housing market is not always good news for builders.

He points out that many are already positioning themselves for the cycle to turn against them as early as 2016. That is not to say that house prices will fall, but rather that builders will find conditions harder because there will be more competition. As share prices are already pricing in profit gains to be made over the next 18 months or so, that leaves values looking full if further gains cannot be expected.

He said: “The large house builders are aware of the cyclicality of the industry and have been planning their output for the next three years – until the next downturn might be expected to occur. While some are increasing their output significantly, for example Persimmon, others such as Taylor Wimpey are taking a much more measured approach, focusing on margin rather than volume.

“What is required to increase the number of new houses to the required level is for smaller, unquoted house builders to return to the market. They have, to date, been frozen out by the absence of finance from the banks.”

Those small firms which have survived thus far have now received a belated boost with the announcement in the Budget of a £500 million builders’ finance fund, which will offer loans to small developers and jump-start building on sites of up to 250 homes.

Williams says the renewed competition will cause problems for the big firms, who have got used to having the market to themselves. “The absence of small house builders from the market has enabled the large companies to buy land at good prices to date and employ much of the available workforce. By increasing the bank finance available to smaller house builders, volumes should start to increase.

“The other side of the coin is that competition for land is likely to increase, labour rates could continue to accelerate and there could be a supply shortage of building materials.

“In essence, there would be a detrimental impact on margins.”

Given that, he thinks shares in some of the builders’ merchants, such as Travis Perkins, are a better way for investors to take advantage of the Budget news than the builders themselves.

However, he expects the extension of Help to Buy should encourage builders to move outside the currently-favoured south-east of England.

In Scotland, builders have been quick to call for the Scottish Government to waste no time in confirming that its own version of Help to Buy will also be extended, a move that is widely expected as consequential funding is in place.

Ed Monaghan, chair of Construction Scotland and chief executive of builder Mactaggart & Mickel, said the certainty provided by a further four years of state backing would actually help tackle any skills shortages north of the Border.

“This allows builders to go out and do things with certainty,” he said. “We can go out and buy new land, seek planning permission and employ apprentices. An apprentice is four years’ commitment for any business and when you don’t have safe work in the pipeline it’s difficult to make that commitment.”

Monaghan has not seen any evidence of rising land prices in Scotland so far.

He said: “We have to be careful we are not swayed by what’s happening inside the M25.”