Property: An Investment or Speculation?

Wednesday, 6th July 2016 08:30 - by David Harbage

According to the Markit/CIPS construction purchasing managers’ survey, in the month of June the UK construction industry experienced its weakest performance for seven years. Such forward-looking surveys are helpful in providing an indication of industry trends – with this one showing a reading of 46 (a fall from 51.9 in May), across an index range of 0 to 100 with 50 being the neutral position.

The survey covers construction of all types, public and private, from building houses to factories and offices. Over the last ten years, the index has ranged between a low of 27 in February 2009 (induced by the banking crisis) and a high of 65 in January 2014. Announced yesterday, this data and opinion would have been sought before the Referendum vote and therefore further gloom (if only based on personal and corporate decision makers stalling on their plans) can be expected next month.

Contractors, house builders and property companies listed on the London stock market were marked down yesterday and have retreated further today, as retail investors digest negative newspaper comments. Aviva and Standard Life suspended dealing in their respective UK real estate funds (which typically wholly invest in property direct, and therefore do not carry high cash balances) as they received redemption requests from their underlying investors. This could lead to forced disposals of property (typically commercial office, retail or industrial estates) to meet such demands. Leading individual property landlords, such as FTSE100 constituent Land Securities and house builders have seen their share prices marked down by 5% both yesterday and today.

An encouraging trading update from the country’s biggest national volume builder (notably by reference to its relatively low exposure to London), Persimmon, covering the first half of 2016 was expected and does not provide an answer to the question of what trading will look like in a year’s time. For the record, Persimmon reported a 6% increase in completions to 7,236 and in average selling prices to £205,500 leading to a 12% increase in revenue to £1.49 billion. Operating margins are set to rise from last year’s 23%, land spend was £305m on 7,100 plots (£300m in H1 2014) and the net cash balance £462m (up from £278 in 2015). Management say that it is too early to judge how the new homes market will be affected by the 23 June decision to Brexit, but they are confident in market fundamentals – notably surrounding unfulfilled demand – and their own ability to manage the business successfully.

Prospective investors in house builders will have to take a view on the extent to which the domestic economy and housing market activity will pause. By contrast with the financial crisis of almost ten years ago – when house builders extended their balance sheets, via buying competitors – most listed firms now have no debt and are better placed to weather any downturn in selling prices or ‘buyers’ strike’. Mortgage pricing (sub 1% on a 2 year, 65% loan-to-value, owner occupied) and availability remains favourable – subject to banks being keen and able to lend. Aided by HM Government’s ‘Help to Buy’ scheme, buying is likely to remain considerably cheaper than renting – subject to gaining access to a 10%+ deposit. However, prospective purchasers might defer action if they believe that prices are set to fall over the coming year. Meanwhile longer term drivers, such as population growth (which will continue to be substantial over the next two or three years) and undersupply of new housing (exacerbated by a slow planning regime at local council level), remain. Time alone will tell how the UK residential property market develops, but increased use of the internet (shopping and service provision) means the pace of demand for commercial property may ease.

Insofar as the home builders are concerned, share prices have now fallen to levels which imply a halving of profits in 2017/18 – notably driven by double digit price deflation. For instance, Persimmon stock is currently valued on a price:earnings ratio of 7.8 times the profits forecast (by a consensus of 15 brokers) for the whole of 2016; which is almost half the wider UK equity market’s rating. At the current 1340p price, the probable 2016 full year dividend of 111p (itself covered by likely earnings of 184p) per share implies a 7.2% income yield.   Analysts have now reduced their expectations for calendar 2017 to anticipate earnings per share of 189p, or 3% growth over the current year, indicating a PE ratio of 7.6x. Incidentally, this company’s track record of being prudently managed (both in its operations and balance sheet) has attracted a premium rating over its peers.

The Brexit affect may depress sentiment further towards London property in particular and persuades for replacing the upmarket builder of apartments Berkeley Group with national (more first time home owner) house builder Persimmon and removing Workspace (which features a portfolio of commercial property within the M25) from the list of selections. Making changes in this List - whose performance is reviewed monthly - is not undertaken lightly (we do not anticipate making many, as the selections represent long term calls), but the vote to leave the European Union represents a major factor to impact equity investment. 

“Being greedy when others are fearful (and fearful when others are greedy)” is probably Warren Buffet’s most repeated quote, but history suggests it has real credence. Certainly the current uncertainty stimulates fear in many and could provide opportunity to some who take a more optimistic view on the domestic economy and the housing market. Maintaining or extending the Help to Buy scheme and financial institutions preparedness to lend is critical to underpinning confidence. A reduction in interest rates alongside other government measures to support sterling and investment in the economy (for example a reduction in corporation tax to 15%) will also help. Sitting on the side-lines and waiting to see how the property market fares over coming months has appeal, but investing in unloved or neglected sectors can prove beneficial if one has confidence in the longer term fundamentals/outlook and can afford to ‘ride out the current storm’.

The Writer's views are their own, not a representation of London South East's. No advice is inferred or given. If you require financial advice, please seek an Independent Financial Adviser.