Housebuilders Slide On Interest Rate Fears, But Is The Housing Market Slowing?

On Thursday night, Bank of England Governor Mark Carney gave his City audience a surprise: interest rates could rise before next year’s general election.

housesThe result was swift and decisive — when markets opened on Friday morning, shares in UK housebuilders fell instantly, by between 5% and 7%.

In a recent article, I warned that housebuilders’ profits could soon come under pressure from a combination of factors, and said that I thought these firms’ share prices might already have peaked.

You see, based on trailing earnings, these companies already look fully priced. If earnings don’t rise as fast as forecast, then UK housebuilders could start to look a little expensive:

Company Trailing twelve month P/E 2014/15 forecast P/E
Barratt Developments (LSE: BDEV) 16.8 11.9
Persimmon (LSE: PSN) 14.8 11.1
Bovis Homes Group (LSE: BVS) 16.8 10.2
Taylor Wimpey (LSE: TW) 15.4 10.1
Berkeley Group Holdings (LSE: BKG) 14.9 10.0

After all, it’s worth remembering that these are not firms which can produce exponential growth, in the way that a high-tech company might do.

All that housebuilders do is buy land, build houses on it, and sell them. Although these firms are currently profiting from cheap land, bought before the market picked up, new land purchases will inevitably be more expensive, and labour and materials costs are already starting to rise.

Any hint of downgraded earnings forecasts could trigger further sell-offs, in my view.

The mortgage question

Housebuilders’ problems could be compounded by changes in the mortgage market.

The Mortgage Market Review (MMR) has resulted in new lending rules that require borrowers to prove they will still be able to afford their mortgage payments when interest rates rise.

According to the Royal Institute of Chartered Surveyors (RICS) housing market survey for May, MMR is already having an effect: RICS says that average perceived loan-to-value ratios are now edging lower across all classes of buyer.

Housing market slowing?

The latest RICS report also flags up trends which suggest to me that housing market momentum is slowing. The average number of new vendor instructions has fallen for five consecutive months, while new buyer enquiries fell to their lowest level since February 2013 in May.

The RICS survey also shows that estate agents are starting to expect a slower rate of price growth. This is a trend that is likely to accelerate as tighter restrictions on mortgage lending take effect — especially as wage growth continues to lag inflation, according to new government data published this month.

Bigger profits elsewhere

In my view, housebuilders’ profits will peak in the next year — and their share prices may already have peaked. 

I firmly believe there is better value elsewhere, including the three firms hand-picked by the Motley Fool's expert analysts for their latest wealth report, "The Fool's Three Shares To Beat Property".

The team's shares picks have gained an average of 28% over the last two years, and I believe the three tips included in this report could do similarly well. I'm especially bullish on a financial stock with strong overseas exposure, which currently offers a yield of 4% and a forecast P/E of just 10.7.

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> Roland does not own shares in any of the companies mentioned in this article.