The UK’s biggest housebuilders, and the home construction market more broadly, peaked in early 2020. Despite the impact of the start of the Covid-19 pandemic, UK housebuilders delivered 242,700 new homes. That was some way short of the government target for 300,000 new homes a year but hasn’t been bettered since.

The share prices of the UK’s 3 largest housebuilders by revenue and profit, Barratt Developments (largest by revenue in 2022), Persimmon (largest by profit in 2022) and Taylor Wimpey (third largest by both revenue and profit in 2022) also peaked in early 2022.

On February 14 2020, the Barrat share price reached a historical high of 870.6p, Persimmon 3282p and Taylor Wimpey 232.4p. A little less than 3 years later and the Barrat share price sits at 444.3p, down 49% from its pre-Covid high and 27.7% over the past year. Persimmon is down 58.4% since February 2020 and 42.85% over 12 months.

Taylor Wimpey has lost over half of its market capitalisation in the past three years, down 51.2% since its high point on February 21 2020 and 22.8% since last January.

However, despite rising interest rates that Persimmon estimates have approximately doubled the cash cost of mortgage payments for some first time buyers over the past year, and a marked slowdown in sales over the last quarter of 2022, the FTSE 100 housebuilders haven’t had a bad start to 2023. Barratt has seen its share price gain over 7% in January, Persimmon is up by a similar amount and Taylor Wimpey’s market capitalisation has improved by 8.5% since the new year bells tolled.

Housebuilder share prices are up in 2023 but the housing market outlook is bleak

Equities markets have generally had a positive start to 2023 after a torrid 2022 for a majority of sectors. Investor sentiment has improved on hopes that the runaway global inflation that has forced central banks into rapid interest rate rises over the past year in an effort to control it is now easing.

Housebuilders have benefitted from that overall uplift as well as the odd number in recent earnings reports proving less bad than feared.

But generally speaking, the past few months have shown a steep drop off in buyer activity and prospects for 2023 look bleak. Barratt Developments recently told investors that unless there is a rebound in reservations this spring, it will deliver between 6% and 9% fewer new homes than previously expected in the year to June. It has also approved just 16 new sites while cancelling 22 previously approved sites meaning a net drop of six sites and 290 plots.

Persimmon says it is starting 2023 with private forward sales of just £500 million against £1.1 billion a year ago and it has no idea when demand will recover. And Taylor Wimpey says sales were ‘significantly’ lower in the final quarter of 2022 and expects volumes to reduce this year. All three have announced hefty cutbacks in new land purchases for the foreseeable future which will also inevitably impact new home delivery pipelines and potential revenues. That knock-on effect was confirmed by Taylor Wimpey CEO Jennie Daly who recently confirmed  “when we slow down on land acquisition it does play through to overall volumes [of new homes built] in the next few years.”

Over 2023, economic recession and higher interest rates are expected to lead to the most significant blow to the residential property market since 2008. Quoted in the Financial Times, Numis housing analyst Chris Millington forecasts a 25% fall in the number of new homes built in 2023 compared to last year. He comments “that’s similar to the first year fall off after the [2008] financial crisis, I’ve only witnessed a fall off like this once before”.

Proposed changes to the planning system that will make it easier for new housing project proposals to be rejected by local communities and the expected abandonment of the government’s target of 300,000 new homes a year are also expected to squeeze the supply of newly constructed homes over coming years.

UK housebuilders look like an attractive investment prospect despite the doom and gloom

A simple rule to avoiding bear traps, companies whose valuations keep dropping despite big recent declines in value convincing investors they are now cheap, is to focus on high quality. All three of the UK’s largest housebuilders, Barratt Developments, Persimmon and Taylor Wimpey tick the boxes for high quality companies in their sector.

They have stable, long-term track records, good management teams, aren’t over-leveraged for their industry, have cash and land in the bank and should be best placed to take advantage when the current housing market slowdown reverses. The UK’s housing market itself does not look likely to suffer from any long-term weakness despite the current headwinds of soft demand, higher costs and the conclusion of the government-backed Help to Buy scheme.

Mid-to-long-term, there are a number of fundamentals that mean the best UK housebuilders should prosper and represent good value at their current share prices. Over the past decade, housing starts in England have averaged 153,000 a year and the country’s population is forecast to grow by 190,000 a year to 2030.  That means a supply/demand imbalance that has existed for many decades isn’t going away.

Also, while mortgage costs are likely to rise further in the short run, interest rates now seem unlikely to reach the extreme levels that have been suggested by some commentators over the past year. Over the past 40 years, house prices have risen at an annualised rate of around 6%, during which time interest rates have mostly been significantly higher than they are today.

While investors shouldn’t bank on the same kind of house price rises we’ve experienced over the past few decades continuing, there are good arguments why affordability means that’s not realistic, nor should a market collapse be expected. The supply-to-demand imbalance will almost certainly keep prices healthy for the foreseeable future despite it becoming increasingly difficult for first time buyers to get onto the property ladder.

Which is the best UK housebuilder to buy shares in?

Source: Motley Fool

Persimmon’s drop in value over the last year means it trades on a forecast price-to-earnings ratio of less than 6 at a time when the FTSE 100 index is close to a record high. It has £860m in cash, which means the resources to not only cope with a period of reduced housing transactions but to capitalise on falling asset prices via selective purchases of land. This should improve long-term returns and boost profitability as a housing market recovery ultimately begins.

Taylor Wimpey finished 2022 with £864 million in net cash, almost £30 million more than a year earlier, mainly due to reduced land purchases. The company’s operating margin even improved last year and a debt-to-equity ratio of 2% and excellent dividend cover of 2.1 times is a solid foundation for investors buying in now with a long term horizon, even if 2023 proves a tough environment.

The company also has a secure dividend policy and aims to pay out at least 7.5% of its net assets, or at least £250 million, annually. At its current share price, the dividend yield would still be slightly over 6%, even in the group’s worst-case scenario.

Barratt Developments has seen its net cash position decline 15% from the end of 2021 to the end of 2022 but it still stands at a very healthy £965 million, giving it plenty of purchasing power to take advantage of presumed lower land prices over the coming period. The company has also launched a £100 million share buyback programme and its dividend yield is currently a very attractive 8.3%.

The conclusion has to be that the immediate outlook for all three of the UK’s largest housebuilders looks tough and potentially volatile as market sentiment swings over coming months. However, most analysts agree that their valuation drops over the past year already largely price in a bleak 2023.

When market sentiment might shift in a way that will lead to a sustainable share price recovery for Barratt, Persimmon and Taylor Wimpey is impossible to call. But healthy dividend yields from all three, and the prospect of significant capital gains when conditions do take a turn for the better due to their strong balance sheets and established market positions, means they all currently look like they offer good value.

There are never any guarantees but it would be a major surprise if an investment in these housebuilders now did not prove successful a few years down the line, provided investors are happy to sit tight and ignore short term volatility that could see things get worse before they improve.