Interactive Investor

Property panic claims mass casualties

6th July 2016 12:42

Lee Wild from interactive investor

It's been a shocking couple of weeks for the housebuilders. With the sustainability of sky-high house prices already causing serious concerns, a vote to leave the European Union was another nail in the coffin of this highly cyclical sector. Now, the hammer is out again as managers at Standard Life, Aviva and M&G (expect more) rush to prevent an exodus from real estate funds. The industry could be in real trouble. More nails please!

Surveying the wreckage of this latest rout reveals the scale of property's impact on the London stockmarket. Of the 50 largest fallers on the FTSE 350 index, 35 are in some way linked to the property sector. That's 70% of the worst performers.

Taylor Wimpey, Barratt Developments and Persimmon, the three largest listed housebuilders, have each lost £2.3 billion of value - about 38% - since the Brexit vote. Mid-cap peers Bellway, Redrow, Galliford Try, Bovis and Crest Nicholson are also nursing massive losses.

But look around and property is causing carnage all over the place. Challenger banks Shawbrook, OneSavings and Aldermore are the biggest losers, down 53%, 46% and 45% respectively. They're not only big lenders to small businesses, which are vulnerable in a downturn, but also to buy-to-let investors who were already under immense pressure from chancellor George Osborne's tax hike on second properties and cuts to mortgage interest relief.

Some, like James Hamilton at Numis Securities, think "the market is wrong", certainly about Aldermore. The discount to net tangible assets and forecast PE ratio in low single-digits prices in a recession "materially worse than the credit crisis," he says. "Consequently, you should either sell everything or buy Aldermore."

But domestic banks are heavily exposed to commercial real estate (CRE) loans, especially Royal Bank of Scotland and Lloyds. Admittedly, it's not what it was, but the big British banks have £69 billion on the line, and the building societies and challengers about £17 billion, according to JP Morgan, and at higher loan-to-values (almost a third at 70% or more).

Elsewhere, suppliers like Travis Perkins, Grafton and SIG have crashed, high-end estate agent Savills is down 26%, and Henderson and Legal & General, who both run real estate funds, are hurting.

It's tempting to think that these stocks look cheap, certainly the housebuilders, many of which are currently trading on just 6-7 times forward earnings and yielding 8-9%. Dividends are currently well covered by earnings, but, hammered in the last recession, housebuilders now prefer paying special dividends planned over a number of years rather than committing to a regular, more predictable payout.

That makes it easier to skip payments when the cycle turns against you - and it will, eventually. The days where loose monetary policy and record low interest rates propped up the housing market cannot last forever.

So why aren't we all buying housebuilders?

The reason investors are scared is clear in the share price chart for 2007-2008. When things hit the fan as the financial crisis took hold, Taylor Wimpey plunged from over 400p to 3.25p in 18 months! Barratt Developments collapsed from 840p to 17p and Persimmon from over 1,500p to around 200p.

Taylor Wimpey lost over £1.5 billion in the first six months of 2008 following massive write-downs on the value of its land. It had racked up huge debts in a pre-crisis expansion drive and there were very real concerns it could go bust before a £510 million capital raise.

Already we're hearing stories about "gazundering", where buyers are lowering offers at the last minute. It's a nasty business and sours sentiment further. The YouGov/CEBR Consumer Confidence Index has just fallen to its lowest level since May 2013, and half of all companies admit to feeling pessimistic about the UK economy, twice as many as before the EU vote.

And while traditional valuation metrics might scream value, investors always look at price/net asset value (NAV) when trading property companies, and here the prognosis is not great.

The table above shows many housebuilders are still trading at a premium to NAV, and in excess of their 10-year average. If Brexit, or other negative catalysts cause a collapse in the housing market, expect to pick them up at a big discount.

Of course, the collapse in sterling makes UK property much cheaper for overseas investors, but Brexit uncertainty has already convinced many foreigners with deep pockets to give Britain a wide berth, at least until the situation becomes clearer.

Recent trading updates from the sector have been largely positive, with prices up and demand still strong. The population is growing and we're building nowhere near enough houses to cope with demand. That, and much stronger balance sheets this time, explain why I don't think we're heading for a 2008-style collapse.

The long-term outlook, then, is positive. Short-term, however, it isn't. Until we understand more about our post-Brexit world, and hear more from housebuilders about demand trends over the next two months, investors will continue to steer clear.

One for the calendar: Taylor Wimpey reports interims on 27 July.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

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