I. Sector landscape and outlook

The UK housing market has tumbled because of COVID-19 pandemic, but optimism is growing in parts. The UK property market reopened last month after weeks of strict lockdown preventing viewings, and financial hardship, bringing significant uncertainty to buyers and sellers. UK house prices had started to recover from uncertainty caused by Brexit at the end of 2019 after PM Johnson returned to the Downing Streets with a stonking majority, but the outbreak of coronavirus bring the sector to a standstill. However, the situation is likely to improve going forward as the government has eased the restriction and decided to reopen the economy.

Key Statistics
House price growth in the UK has slowed since mid-2016 but has picked up in recent months. According to the latest data released by the ONS, the UK average house prices increased by 2.1% over the year to March 2020 and 2.0% month on month from February 2020. Average house prices increased over the year in England to £248,000 (improved by 2.2%), Wales to £162,000 (up 1.1%), Scotland to £152,000 (increased 1.5%) and Northern Ireland to £141,000 (up 3.8%).

London was the English region with the highest annual house price growth, with prices increasing by 4.7% to £486,000 in the year to March 2020, up from 3.0% in February 2020. The lowest annual growth was in Yorkshire and The Humber, where prices decreased by 1.0% over the year to March 2020.

Fig 1: Annual house price rates, UK, January 2006 to March 2020:


Source: ONS
 
Fig 2: Annual house price rates of change, by English region (year to March 2020)

Source: ONS
 
New supply: planning approvals: Data from the Home Builders Federation (HBF) showed that 69,340 homes were granted planning approval in London in the year to Q3 2019. This is down 7% on an annual basis and is the first fall in annualised approvals in two years. In England, annualised housing approvals were down 3% year over year. The average number of homes approved per project remained high compared with historic levels, with 31 homes approved per project in the year to the end of Q3 2019.

New supply: completions: Energy Performance Certificates (EPCs) are required for all new homes, and EPC data1 can be used as a proxy for completions. EPC data has tracked the LDD net conventional completions data over recent years. There were 42,630 new home EPCs registered in London in 2019/20, a slight decrease of 2% from the 43,520 new home EPCs recorded in 2018/19 but signalling another strong year of housing completion.

Fig 3: Energy Performance Certificates for new dwellings in London


Source: GLA

Mortgage lending: There were 40,800 new mortgages advanced to first-time buyers in London in 2019, which is slightly less than the number of loans advanced in 2018 (41,000). The number of loans to home movers in London in 2019 was 27,000, down slightly from 27,500 in 2018. The average price paid for a home in London by first-time buyers was £442,400 in 2019, and the average deposit amount was £143,400 – these amounts have increased 29% and 42% over a five-year period, respectively. The average combined gross household income of a first-time buyer was £82,900 in 2019, and the mean age of the first-named borrower was 33.

Fig 4: Annualised mortgage advances to first-time buyers and home movers


Source: UK Finance

Covid-19’s impact on the UK housing market

According to the latest survey by the Royal Institution of Chartered Surveyors (RICS), House prices in the UK and activity had been reviving since the start of 2020, helped by reduced Brexit and political uncertainty hovering over the British economy. But this trend has gone sharply into reverse post the outbreak of COVID-19. As agents closed their doors due to the lockdown, the spread of the virus across the UK has led to a near standstill of the housing market. Sales expectations for the next three months are now at the weakest of any time since RICS started surveying its members on this in 1998, and price expectations for the coming months are the lowest since the financial crisis. Survey data indicates that the years of inventory held by surveyors – the number of years it would take to sell all properties marketed for sale at the current sales rate – decreased in London in Q1 2020 to 1.0, following a strong start to the year. There have been sharp drops in both demands (as measured by new buyer enquiries) and supply (as measured by new instructions) of homes for sale, following the onset of the Covid-19 pandemic. Surveyors' expectations for sales and house prices fell sharply in Q1 2020. Reported falls in expected sales and expected house prices were more widespread in March 2020 than at any point on record, including during the financial crisis.

Fig 5: Years of inventory on surveyors’ books (average stocks divided by average sales).

Source: RICS

Key Initiative taken by the Government to revive UK House Market

On June 30, PM Johnson has announced reforms to the homebuilding sector. Under the new rules, existing commercial properties, including newly vacant shops, can be converted into residential housing more easily, in a move to kick start the construction industry and speed up rebuilding.

These announcements come alongside a package of measures to support home building across England including:
 

1. A £12bn affordable homes programme that will support up to 180,000 new affordable homes for ownership and rent over the next 8 years.

2. Included in the affordable homes programme will be a 1,500 unit pilot of ‘First Homes’: houses that will be sold to first time buyers at a 30% discount which will remain in perpetuity, keeping them affordable for generations of families to own.

3. Funds from the £400m Brownfield Land Fund have been allocated to the West Midlands, Greater Manchester, West Yorkshire, Liverpool City Region, Sheffield City Region, and North of Tyne and Tees Valley to support around 24,000 homes.

4. The Home Building Fund to help smaller developers’ access to finance for new housing developments will receive an additional £450m boost. This is expected to support the delivery of around 7,200 new home.
 

Further, on July 6, Housing Secretary Robert Jenrick announced a scheme to help get more families across England into affordable homes and extended the scheme by a year. Homes to be built under the Government’s £9 billion scheme earlier expected to be commenced by March 2022. However, Robert Jenrick announcement means that housing associations and councils have a year longer to begin building these homes while still receiving Government support, giving them the flexibility and certainty, they need to keep building across the country.
 
Risk

The unemployment rate is likely to increase in the country owing to COVID-19 pandemic. Consequently, consumer spending is likely to reduce in the near to medium term, which might dent the demand. Further, the next phase of lockdown in the wake of the second wave of COVID-19 outbreak could result in lower demand, a shortage of labour and shut down of operations.

Valuation & Outlook for the stocks under coverage

The Homebuilding stocks have plummeted significantly year-to-date basis as compared to fall in the broader indices. On a YTD basis, FTSE All-Share Homebuilding stocks have tumbled approximately 31%, whereas FTSE AllShare index slumped 17%, which reflects the underperformance of the UK Homebuilding stocks against the benchmark index. However, these stocks have recovered to some extent after a steep fall, which was driven by the panic selling emerged in March 2020 because of the outbreak of Covid-19 in the UK. The lockdown measures were also in place to curb the spread of the virus, which had a huge weigh on the housing sector as construction activities were shut, buyers turned muted, and many deals negotiated earlier was on pause. Now gradually opening the UK housing market supported by government stimulus and radical reforms in the housing sector, bringing Homebuilding stocks into the limelight. Further, companies under our coverage: PSN, BDE, BKG, and BWY are among the best in class within the homebuilding sector, with a strong balance sheet, solid margin profile, ability to generate free cash flow, and lower debt contribution in the balance sheet.
Further, the sector is trading at a discounted valuation in terms of Price-to-Book value multiple, the 12 FTSE All-Share Homebuilding stocks trading at 38% discount to their 5-year average Price-to-Book value multiple of 2.05x. Stocks under discussion are trading at an approximately 17% discount to their 5-year average Price-to-Book value multiple.  Also, a lower interest rate environment and other support from the government are expected to revive demand in the coming quarter.
 
II. Investment theme and stocks under discussion (BDEV, BKG, BWY and PSN)

After understanding the recent trends in the industry, let’s now look at the four players those are listed on the London Stock Exchange. To assess the price potential, companies’ stocks are evaluated based on Discounted Cash Flow (DCF).