Robert Stephens, CFA, discusses the outlook for the property sector at a time of great uncertainty.
The Covid-19 pandemic has caused disruption across the UK property market. Residential and commercial property businesses face a period of lower sales and profitability that has, in many cases, prompted sharp falls in their share prices.
More of the same could be ahead in the short run. But the wider property sector could experience a return to growth in the long run that may make the low valuations on offer at the moment seem highly attractive, in my opinion.
Mass-market housebuilder
The UK’s largest housebuilder, Barratt (LON:BDEV), closed all of its sales offices and construction sites for much of the lockdown period. Even though they have since started to reopen, the company expects reservations and completions to be very limited.
Barratt seems to be in a good position to survive a drop in sales. It has £450 million in cash, as well as various banking facilities that are available should they be required. It has suspended non-essential expenditure, and cancelled its interim dividend to further preserve cash.
Longer term, the firm could experience a return to high demand for its new homes. Low interest rates may further reduce the proportion of disposable income spent by homeowners on their mortgages. Other factors such as an undersupply of housing versus demand and supportive government policies such as Help to Buy could catalyse the financial performance of the wider industry in future years.
Covid-19 is causing extremely challenging trading conditions for Barratt. But it looks set to survive in the short run, and may deliver capital growth in the long run.
Prime housebuilder
Occupying a different niche of the housing industry than volume builder Barratt is prime property developer Berkeley (LON:BKG). Even though it built over 10% of London’s new homes in 2019, it focuses on properties with a higher price point than many of its FTSE 100 sector peers.
Berkeley has a net cash position of around £1 billion, in addition to bank facilities totalling £750 million. It has previously used periods of economic uncertainty to purchase land while it trades at a low price. This strategy could be successful should asset prices experience a U-shaped recovery, rather than a V-shaped recovery that doesn’t allow time for land values to fully reflect economic uncertainty.
The firm has a solid market position. Its long-term focus means that it can engage in complex projects that many of its peers may struggle to replicate, which could lead to strong profit growth in future.
REIT
The financial performance of REITs such as Land Securities (LON:LAND) has already been affected by Covid-19. The company reported that it collected just 65% of rent due in March compared to 96% in the same month of the previous year.
The closure of retail, leisure and hotel units is likely to mean Land Securities experiences a further decline in its rental income as the Covid-19 lockdown continues. In response, it has cancelled its dividend, while its £1.2 billion of cash and loan-to-value (LTV) ratio of 28% suggest that it has the capacity to withstand further disruption over the medium term.
Asset prices and rents are likely to fall if, as expected, the UK experiences a recession. However, Land Securities owns a range of attractive properties. Its share price is 38% down year-to-date, and could offer a margin of safety.