SPECIAL FEATURE: House builders struggle to rally

The UK housing market has always been very much a demand driven market with valuations usually significantly out of kilter with average incomes. This is largely down to outdated planning regulations that make it very time consuming to obtain permission to build new properties where they need to be.

London house prices in particular continue to rise exponentially through valuations that have little to do with mortgage availability or the lack of it, given the amount of foreign money coming into the property market here.

Recent Purchasing Managers Index data have shown that housing continues to drive the recovery in the UK economy yet house building stocks have started to slip back since the recent highs in March.

A large part of this decline can be put down to the Mortgage Market Review, which in April set out new rules on affordability tests on new mortgages, over concerns that the old habits that led to the financial crisis in 2007, were starting to make a comeback.

To recap, the Mortgage Market Review are guidelines set out by the FCA to ensure that any new lending was affordable and that new borrowers had enough of a financial buffer to absorb a rise in interest rates, or a change in personal circumstances.

Even accounting for these changes, mortgage approvals data has shown a slowdown in recent months, though it did pick up again in June it still remains lower by historical standards and the boom years of 2006, but it is catching up. In fact, according to the Council for Mortgage Lenders the amount borrowed was back at levels last seen at the end of 2007, with high loan to value borrowing showing a sharp increase.

This was a particular problem in 2007 and has prompted the Bank of England to introduce new LTI caps at the end of June, to help stem this problem, and this could prompt a further slowdown in the coming months.

Yet despite the likelihood that demand for new homes particularly in London and the south east is likely to remain high, we’ve seen a gradual decline in the value of the house building sector as a whole since the peaks seen in March.

Some of this can be put down the fact that in the past few years we’ve seen a significant rebound in the share prices of all major house building firms since the lows in 2010/2011, and it’s likely that the current fall is more down to a bout of profit taking.

Given that most of the major house builders trade on fairly low forward P/E, the puzzle remains as to why investors remain reluctant to push back into a sector, that on the face it is likely to see a consistent demand for newly built properties.

With UK house builders set to report their latest numbers over the next few weeks investor focus is likely to be on the outlook for earnings growth over the next twelve months, starting with Bovis Homes and Persimmon on the 18th and 19th August respectively.

At its last trading update in June, Persimmon was fairly conservative due to concerns about a lack of supply of available land, so while demand was solid, supply could well limit future growth.

Bovis Homes on the other hand was quite bullish in July and is expected to announce that completions rose 54% in the first half with average selling prices by 11%, putting it on course for a full year pre-tax profit of £130m.

One of the reasons behind the reluctance to push valuations higher could well be the fragmented nature of the recovery in house prices throughout the UK since the peaks in January 2008.

We hear an awful lot of headlines about froth in the UK property market, but on average UK house prices are only 6.5% above their peaks six years ago, with 31.6% of that increase in the London area alone.

Only two other regions in the UK have recovered their 2008 peaks, with the South East seeing a 7.1% gain and the East of the country a 4.7% gain, according to April ONS data.

Every other region in the UK remains below its 2008 peaks with the biggest declines in the North East and North West regions.

Taking London and the South East out of the equation gives you a completely different outlook on the health of the UK housing market and maybe that, more than anything, underlines the fragility of the recent rebound in the housing market in the UK in the last two years.

With house price valuations still below their 2008 levels elsewhere in the country the incentive to move is likely to be nowhere near as high, given that you could well be taking a loss on your current property investment, particularly if you bought prior to 2008.

So while the short term outlook for housing is likely to remain positive, all the talk about elevated house prices as well as the uncertainty over the timing of a possible interest rate rise, and recent measures to limit mortgage availability, has made investors more cautious about piling into a sector that remains notoriously sensitive to cyclical cross winds.

Rising valuations, shrinking average incomes and the prospect of a rise in interest rates in the next twelve months could well be generating some caution in investors' minds.

Having said that, on a long term view most of the major house builders trade on a fairly low forward earnings estimate, relative to the FTSE100, and with housing demand set to remain strong, the prognosis is likely to be a good one for investors prepared to take a long term view.