Housing crisis makes this house builder a strong buy

In recent decades, house prices have become a national obsession. Other countries across Europe seem to lack this constant focus on how much house prices have changed in the last month, quarter or year. However, in the UK the love of rising house prices looks set to stay in the long run.

The reason for this is a continued imbalance between demand and supply. Put simply, there are not enough houses built each year to satisfy demand, so prices continue to rise. Therefore, buying a house or investing in companies which build them has proven to be a sound investment strategy in the past and is likely to continue to be so in the long run.

This year, though, looks set to be the exception. The Brexit effect on business confidence, inflation, and consumer confidence is yet to come in my view. As such, house prices could fail to march upwards this year, which I think makes now a good time to buy house builder Taylor Wimpey (LON:TW).

Brexit shock

Since the EU referendum, it’s been a case of so far, so good for the UK economy. It’s performing relatively well and apart from a weak pound and modestly higher inflation, nothing much has changed. However, I believe things will change and this could hurt house price growth in the short run.

Specifically, a weak pound is likely to cause significantly higher inflation. Already, inflation has risen from 0.5% in June 2016 to 1.6% in December 2016. The Bank of England expects it to hit 2.7% this year, but other forecasters are much more hawkish. In any case, there is a good chance inflation will surpass wage growth this year and cause consumers to have less disposable income in real terms than they had last year.


The effect of this on house price affordability could be negative. Individuals and couples seeking to buy houses may find mortgage repayments less affordable, since the cost of consumables may rise faster than their wages.

Further, higher inflation may prompt the Bank of England to become less dovish than expected, since weaker sterling may provide a stimulus to the UK economy so that lower interest rates are no longer necessary. Similarly, higher inflation could cause a desire among policymakers to cool off the rapidly rising price level. Therefore, mortgage rates may no longer be as attractive, which could have a knock-on effect on house prices in the short run.

Long-term growth

Despite the above, I remain bullish on house prices over a long-term timeframe. Such is the deficit of supply versus demand that I believe house prices will rise for decades in the UK. Political parties usually promise to tackle the problem of lack of housing, but recent governments have instead focused thus far on demand-side policies, rather than supply-side policies.

For example, the current government has introduced Help to Buy. While that helps individuals/couples to buy a house, it does not address the fundamental issue of a lack of supply.

Over the next decade, the UK’s population growth is forecast to outstrip the number of houses built by approximately 300,000 per year.

Over the next decade, the UK’s population growth is forecast to outstrip the number of houses built by approximately 300,000 per year. Not all of those people will require a house, since people often share houses. However, even factoring that point in, it seems likely the current imbalance between supply and demand will worsen, rather than get better over the long run.

Priced for success

Given the uncertainty regarding the short-term outlook for the housing market, it’s not a surprise that house builders like Taylor Wimpey have low valuations. It has a P/E of 9.6, which at a time when the FTSE 100 is within 200 points of its all-time high indicates good value in my view. Therefore, even if house prices dip this year, I feel this has already been factored into the company’s valuation and its shares could benefit from strong support during the course of the year.

Similarly, I find Taylor Wimpey’s yield of 8.1% (including special dividends) difficult to justify. It pays out 75% of EPS as a dividend, which seems reasonable given forecast EPS growth of 4% this year and 5% next year. Even if profit falls, dividend cuts are not a given in my opinion.


Just as I have taken a long-term view on the housing market, even in the face of uncertainty in the near term the company’s management could do likewise. This may lead to dividends holding up better than expected, although admittedly special dividends could be put under pressure if the company’s performance deteriorates.

Taylor Wimpey has a solid short-term landbank of 76k plots. It is likely to remain disciplined in terms of being selective in further land investment. Its strategy is relatively cautious, while I feel that a net cash position of £365 million means its balance sheet should be able to withstand potential difficulties in trading conditions in the short run.

Outlook

In my view, investing in house builders at the moment means an acceptance that things could get worse in the short run. The full effects of Brexit are yet to play out, but the signs are already there in my opinion as to what could happen next. Weaker sterling plus higher inflation could ultimately make mortgages less affordable this year, which could have a knock-on effect on house prices.

However, I believe this risk is priced in to Taylor Wimpey’s valuation. It has a single-digit P/E and a yield which is more than twice that of the FTSE 100. Therefore, I believe its shares could enjoy support in the short run. In the long term, the supply deficit of UK houses is likely to worsen in my view as house building fails to match population growth. This should push house prices ever higher, which makes me optimistic about the long-term prospects for Taylor Wimpey and the wider house building sector.