UK Housebuilder Stocks: Buy on Rate Cuts or a Value Trap?

Supply has its own problem. The government promised 1.5 million homes in England over this parliament. An official estimate from the housing ministry puts the total so far at 437,900, which is 29% of the target. About 44% of the parliament has already passed. This piece looks at why margins collapsed, what valuations say about past cycles, how Vistry fell apart, and whether that discount to book value is an opportunity or a trap.

Watch it play outUnder a third of the homes, more than two-fifths of the time

Picture the promise of 1.5 million homes in England this parliament as 100 dots.

So far 437,900 have been delivered. That lights 29 of the dots.

Now the clock. About 44% of the parliament has already passed.

The homes ring has filled only 29%. Delivery is falling behind the clock.

Replay

Why are UK housebuilder shares so cheap?

The usual way to value a housebuilder is to compare its share price with its tangible net asset value (TNAV). TNAV is shareholders' equity minus goodwill and other intangibles. For a builder it is mostly land, unsold homes and work in progress, plus cash, all at historic cost. A builder that earns more than its cost of equity on those assets deserves to trade above 1x. One that earns less trades below it.

UBS put the sector at 0.74 times tangible book in its latest sector review, as interactive investor reported. The low after the financial crisis was 0.6 times and the long-run average is 1.4 times. Shares in the sector had fallen an average of 22% this year by then.

The sector trades near its post-crisis low, far below its long-run average

Post-crisis low1x

Now1x

Long-run avg1x

0.40.60.81.01.21.41.6x

Using the latest closing prices from Stock Analysis and each company's latest reported asset values, the big five look like this. All amounts use £1 = $1.32.

Only Persimmon trades above the value of its assets

Persimmon1.09x

Berkeley0.81x

Barratt Redrow0.68x

Taylor Wimpey0.66x

Share price divided by tangible assets per share (Barratt Redrow, Taylor Wimpey) or net assets per share (Persimmon, Berkeley).

Persimmon is the exception: it earns the best margins among the volume builders and is growing. The market values Barratt Redrow and Taylor Wimpey as if their assets were worth about a third less than book value. Barratt Redrow estimates the gross margin left in its land bank at 17.3%, down from 19.2% a year earlier. Land bought when prices and incentives looked different earns less once it becomes homes.

How far have margins and returns fallen since before the pandemic?

Building homes is a business with high fixed costs. A builder pays for land, roads, sewers and site teams before it sells a single home. So when volumes drop, profits drop faster.

Every volume builder earns roughly half its pre-pandemic margin

Pre-pandemicLatest

10203040%0

30.3%12.8%

PersimmonPre-pandemic30.3%Latest12.8%

18.9%9.9%

BarrattPre-pandemic18.9%Latest9.9%

19.6%7.7%

Taylor WimpeyPre-pandemic19.6%Latest7.7%

PersimmonBarrattTaylor Wimpey

Persimmon's housing operating margin was 30.3% in its last full pre-pandemic year, according to its annual report. In its latest half-year it was 12.8%. That was still above analysts' forecasts and the best of the volume builders. Its full results statement shows the underlying gross margin fell from 20.1% to 18.0%. The reasons were more low-margin sales to housing associations, incentives worth about 5% of the price, and build-cost inflation that it expects to run at 3% to 4% this year. Persimmon puts the extra inflation cost at £40 million to £50 million over the next 18 months. Its target is still a 20% operating margin and a 20% return on capital. It currently earns 11.3%.

Taylor Wimpey has it worse. Its half-year results show a 7.7% operating margin, against 19.6% in its last pre-pandemic year, according to its results from that year. Back then it completed 15,520 UK homes, not counting joint ventures. This year it guides to 10,600 to 10,800. Net cash nearly halved to £168.6 million. It replaced its dividend policy with a payout of 4% of net assets a year, because the downturn "has proved more prolonged than anticipated."

Check the claimThree things investors assume about housebuilders

ClaimMerging two big builders brings back pre-pandemic volumes.Tap to checkMythBarratt Redrow completed 17,667 homes, fewer than the 17,856 Barratt built alone before the pandemic. It has also cut next year's guidance because of planning delays.Flip backClaimHousebuilders are cash machines that always pay big dividends.Tap to checkMythTaylor Wimpey's net cash fell from £342.6m to £168.6m in six months, and it cut its payout policy.Flip backClaimCladding bills are still coming out of shareholders' cash.Tap to checkFactTaylor Wimpey still has a £382.9m provision and expects about £100m of cladding spending this year. Persimmon has £205.6m left.Flip back

Berkeley, which builds mostly London flats, has held its margin. The best way to see that is its full-year results: a margin of 18.7% on 4,076 homes and pre-tax profit of £451.4 million. But it has "stopped acquiring new land", because it can't earn its required return on new sites. It is shrinking its share count instead, spending £233 million on buybacks last year.

What does the cladding bill still cost?

After the Grenfell Tower fire, builders agreed to fix unsafe cladding and other fire-safety defects on buildings they had put up. Those costs still weigh on balance sheets. Taylor Wimpey's provision stands at £382.9 million and it expects about £100 million of cash to go out on cladding this year. Persimmon has £205.6 million left after spending more than £200 million. A new Building Safety Levy on new homes starts this year as well. Taylor Wimpey says its existing sites won't pay it until three years from now.

What was the CMA case about?

The Competition and Markets Authority (CMA), Britain's competition regulator, investigated whether seven builders had shared sensitive information such as sale prices: Barratt Redrow, Bellway, Berkeley, Bloor, Persimmon, Taylor Wimpey and Vistry. The case closed last year, Property Week reported. There was no finding of wrongdoing. Instead the builders made binding commitments for five years and paid a combined £100 million towards affordable housing. Persimmon booked a £16.2 million charge for its part and Taylor Wimpey £18.0 million. The cost was small. The bigger risk is the collective damages claim proposed afterwards.

What do mortgage rates and the Bank of England mean for housebuilders?

Most new-build buyers need a mortgage, and first-time buyers made up 36% of Persimmon's private completions, so demand depends on the cost of borrowing. In the UK most borrowers take a fixed rate for two or five years. Those rates follow gilt yields and swap rates more than Bank Rate itself. Gilts are UK government bonds, and their yields set the cost of longer-term borrowing.

At its latest meeting, the Bank of England's Monetary Policy Committee (MPC), the nine people who set Bank Rate, held it at 3.75% by six votes to three. All three dissenters wanted to raise rates. Conflict in the Middle East has pushed up energy prices and CPI inflation to 3.1%, and the Bank expects inflation to pass 4% early next year. Around the time of UBS's review, the 10-year gilt yield hit a 19-year high of 5.28%.

Mortgage rates sit far above Bank Rate because markets expect hikes

Five-year fix6.00%

Two-year fix5.98%

Two-year fix, 2 yrs ago5.54%

10-year gilt5.28%

Bank Rate3.75%

Moneyfacts average fixed mortgage rates. The gilt yield is the 19-year high set around the time of UBS's sector review.

Moneyfacts figures put the average two-year fix at 5.98% and the five-year at 6%, their highest in about three years. The number of fixed deals priced below 5% fell from 1,494 to 9 in a month. Two years ago the average two-year fix was 5.54%, so the hoped-for relief from rate cuts never reached borrowers, HomeOwners Alliance notes.

House prices show the strain. Nationwide says annual growth halved to 0.8% in the latest month, to an average of £274,251. The official UK House Price Index, which runs a couple of months behind, shows 1.4% growth to £273,000. Inflation is running above 3%, so real house prices are falling. Nationwide's chief economist notes the upside: incomes have been rising faster than prices for some time, so affordability is quietly improving.

Make a guess

Inflation is 3.1%. By how much did Nationwide's house price index rise over the latest year?

Tap your guess

Less than 1%Your guess1% to 3%Your guessMore than 3%Your guess

0123456789.0123456789%Annual house price growth

Spot on.Close, a little low.Close, a little high.Way off, too low.Way off, too high. It was 0.8%.

0.8%, half the previous month's 1.6%. After inflation, the average home lost value, which means builders can't raise prices to offset 3% to 4% cost inflation.

This is why "buy housebuilders on rate cuts" has stalled. The trade assumed lower mortgage rates would bring buyers back, sales rates would rise and margins would recover. The cuts stopped at 3.75%. Berkeley blamed buyer caution on "uncertainty over the timing of interest rate reductions."

Is Help to Buy coming back, and does it help?

Help to Buy was a government equity loan for buyers of new-build homes. It supported about 387,000 purchases over a decade before it closed, and builders did very well out of it. Persimmon's margins topped 30%, and its then chief executive earned a bonus of around £75 million, which led to a shareholder revolt. Critics say it also pushed up the prices of new homes in places where it wasn't well targeted.

Vistry jumped most on the equity-loan announcement

Vistry22%

Persimmon15%

Taylor Wimpey15%

Bellway14%

Barratt Redrow13%

Share price moves on the first trading day after the Prime Minister announced Your First Home.

Your First Home is a smaller version of the same idea. It is for first-time buyers in England only, with a 2.5% deposit, a 20% state loan that starts interest-free, and caps on household income and property price. Developers must join the scheme and pay a fee, probably linked to the home's value. The Home Builders Federation (HBF), the industry's trade body, has proposed starting at 1% of the sale price. The full details come in the new chancellor John Healey's first Budget.

Builders lobbied for this scheme. Taylor Wimpey asked for an equity loan scheme, stamp duty relief for first-time buyers and a review of the costs added since the start of the decade, which the HBF puts at about £76,000 per home. But the shares' failure to hold their gains points to two doubts. First, the fee and the price caps will take a share of each sale. Second, an interest-free loan doesn't change the 6% rate on the other 77.5% of the price.

Can planning reform deliver 1.5 million homes?

Planning reform was meant to be the supply-side answer: faster permissions, more land released and targets for councils to meet. The builders say it isn't working on the ground yet. Barratt Redrow cut next year's guidance to 17,500 to 17,900 homes, citing "continued planning delays" and fewer site openings. Persimmon calls the reforms welcome but says they "still need to translate to faster change on the ground." Taylor Wimpey reports some friction with councils since the local elections.

Net new homes have fallen every year this decade

50,000100,000150,000200,000250,0000

234,460

234,290

221,410

208,600

196,900

4 yrs ago3 yrs ago2 yrs agoLast yrLatest

The latest full official count was 208,600 net additional homes, and the estimate for the year after is 196,900. To reach 1.5 million, England needs about 1,062,100 more homes in the time left. That is roughly 380,000 a year, far above the best recent year of 234,460.

Housing starts point the same way. Builders started 35,910 homes in the latest quarter, which is about 144,000 a year at that pace. That was 20% more than a year earlier, but 47% below the peak three years ago. Part of the rise comes from starts reported by the new Building Safety Regulator, which oversees high-rise projects. Most homes that aren't started in the next year or so won't be finished before the next election.

Find the number

Which figure tells you most about whether the 1.5 million target can still be hit?

Housing supply, Englandhomes

Net homes added in the latest year (estimate)196,900This measures completions, which reflect starts from a year or two earlier.Homes delivered so far this parliament437,900This is the score so far. It doesn't tell you the pace from here.New-build starts in the latest quarter35,910Starts are the pipeline. About 144,000 a year at this pace, against roughly 380,000 needed.The target1,500,000The target hasn't changed. The pace needed to meet it has gone up.

Tap the line you think is the tell.

Spotted it.Not that line. Starts. At about 144,000 a year, the pipeline is well under half the pace needed, so the target depends on a demand boost like Your First Home and not just on planning reform.

Explain every lineHide the other explanations

What went wrong at Vistry?

Vistry was meant to be the model for the next cycle. It moved into "partnerships", building homes for housing associations, councils and rental landlords that pay as the homes go up, which uses less capital than buying land and building homes to sell. Its profit warnings show what can go wrong with that model.

Two years of warnings at Vistry

1. 2 yrs agoCosts underestimatedNine southern schemes about 10% over budget; shares down about a third
2. 2 yrs agoHit grows to £165mReview finds problems on 18 sites and blames poor divisional culture
3. 2 yrs agoThird warningDelayed completions and deals hit profit
4. This yrBuyback pausedDiscounting to clear unsold homes; profit guidance cut
5. This yrFirst-half loss£83.3m adjusted loss and £475m goodwill write-down

The first round, two years ago, was about costs. In the southern division, build costs on nine of 46 schemes had been underestimated by about 10%, Construction Enquirer reported. An independent review raised the total hit to £165 million and blamed "poor divisional culture", Housing Today reported. The shares fell by about a third on the first warning. Another warning, about delayed completions, followed within weeks.

This year's warnings were about demand. Vistry discounted unsold private homes to turn them into cash. Its discount on private sales rose from 1.4% to 7.1%. By mid-year the shares were down 63% since the start of the year, ABC Money reported. The half-year results showed revenue down 8.9%, gross margin down from 12.4% to 4.0%, an adjusted loss of £83.3 million and a £475 million goodwill write-down. Net debt rose to £468.8 million. On the results call, new chief executive Adam Daniels said lenders had waived the interest-cover covenant, a loan condition, for this year-end and next half-year, and that it doesn't expect to raise equity. Vistry now has a market value of about £713 million.

Are housebuilders a buy on rate cuts or a value trap?

The case for buying is about valuation and cash. The sector trades at 0.74 times tangible book, against a long-run average of 1.4 times. Barratt Redrow has £772.8 million of net cash and plans a £400 million return to shareholders, mostly buybacks, which is close to a tenth of its market value. Its cost savings from the merger have reached £73 million, with £100 million targeted. Housebuilders are cyclical stocks: the best time to buy has historically been when margins are depressed and price-to-book is near the bottom, not when earnings look good.

Most of the upside depends on returns recovering enough to justify book value

Pick a builder and the price-to-book multiple the market pays in the future

Company

Barratt RedrowTaylor WimpeyBerkeley

Future multiple

0.6x, post-crisis low1.0x, book value1.4x, long-run avg

Share price change−12.1%46.6%105.2%−8.9%51.9%112.6%−26.4%22.7%71.8%

−12.1%+46.6%+105.2%−8.9%+51.9%+112.6%−26.4%+22.7%+71.8%below Today's priceabove Today's priceabove Today's pricebelow Today's priceabove Today's priceabove Today's pricebelow Today's priceabove Today's priceabove Today's price

Today's price 0.0%

−26.4%112.6%

The case against is about returns. A builder deserves to trade at book value only if it earns its cost of equity on that book. Barratt Redrow's return on capital is 9.2% and Persimmon's 11.3%, while the 10-year gilt yields 5.28%. That leaves little extra return for the risk of owning a cyclical business. Rates are more likely to rise than fall, build costs are rising faster than prices, and the regulatory costs keep coming: cladding, the building-safety levy, and the fee for Your First Home. EY counted eight profit warnings from listed housebuilders in the first half, as many as in the first half of the financial crisis year.

Bull and bear cases rest on the same few numbers

BuyValuation and cash

• Sector at 0.74x tangible book vs 1.4x average
• Barratt Redrow: £772.8m net cash, £400m return
• State equity loans for first-time buyers on the way
• Affordability slowly improving

vs

Value trapReturns and rates

• Returns on capital of 9% to 11%
• Two-year fixes at 5.98%, MPC leaning to hikes
• Build costs up 3% to 4%, prices up 0.8%
• Starts far below the 1.5m pace

What are the caveats?

Price-to-book ratios use historic cost, and land values can be written down fast, as Vistry showed. The Your First Home terms aren't final, so the fee and caps could make it more or less generous. Middle East energy prices could reverse quickly and bring rate cuts back into view, which would lift these shares sharply. Persimmon and Berkeley report net assets including some intangibles, so their ratios aren't exactly comparable with the others. For the wider picture, see why UK banks have rerated while housebuilders haven't.

Our read

UK housebuilders are not a simple rate-cut trade anymore, because the rate cuts have stopped. With the MPC leaning towards a hike and fixed rates at 6%, the sector's recovery now depends on government policy, mainly Your First Home, more than on the Bank of England.

We'd treat the sector as two groups. Persimmon and Berkeley are the quality names: Persimmon is the lowest-cost volume builder and is growing completions fastest, and Berkeley holds its margin and is shrinking its share count. Barratt Redrow is the value option, cheap at 0.68x tangible book with a large buyback paid from net cash. Taylor Wimpey and Vistry are where the value trap risk is real: falling margins, falling cash and, at Vistry, a balance sheet that needed lenders' help.

The signal to watch is margins, not rates. If Your First Home sets a fee near 1% and lifts sales rates without heavier discounts, gross margins can stabilise and the discount to book should narrow. If builders keep paying incentives of 5% or more to sell homes while costs rise 3% to 4%, book value will keep falling and the shares will stay cheap.

On balance, a selective position in the strongest balance sheets makes sense at these prices, sized for a cycle that could take years. Buying the whole sector because it looks cheap does not.

Go deeper

• Cyclical companies: how to value a business at the bottom of its cycle, when today's earnings understate what it can earn later.
• Valuation and expectations: why a 0.7x price-to-book ratio is cheap only if returns recover above the cost of equity.
• Capital allocation: how to judge Berkeley's choice to buy back shares instead of land, and Barratt Redrow's £400 million return.

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