Housebuilders – Profit margins, finances and interest rates
February 13, 2024
The housing market is a key part of the UK national psyche. The inexorable rise in house prices has enriched baby boomers, but now unaffordable prices exacerbated by sharply higher mortgage interest rates are destroying the life prospects and restricting the lifestyles of younger generations.
The government talks of supply and demand, sets unrealistic housebuilding targets and tinkers with planning legislation. Developers pay lip service to providing more ‘affordable’ housing within their schemes. The merest hint of a drop in house prices causes panic and acres of media speculation. All the while, those fortunate enough to own residential property which has not been built on a flood plain and who can afford their mortgages sail blithely on in the good ship Wealth Creation.
What of those who create the hardware for this most unlevel of personal finance playing fields: the housebuilders?
Is the perceived wisdom on housebuilders accurate?
In recent years, the view has been that housebuilding is an endlessly challenging market, plagued by high prices for and limited availability of land, soaring material input prices and endemic labour shortages leading to a surge in people costs. This toxic cocktail of negatives has been blamed for the poor quality of some new builds and their steadily shrinking size.
This description has now been vigorously challenged in an article in January 2024 in Grand Designs magazineby its Editor-at-Large, Kevin McCloud on how major home builders are making huge profits. The article is based on research by Brunel University, the findings of which were published in March 2023 in The Conversation under the uncompromising title: ‘Builders are making thumping profits by over-charging for new homes’.
The core suggestions from these two hard hitting pieces are:
- Land prices have remained static in real terms since 1998.
- The return on capital employed for buying land for housebuilding is currently 30% for investors.
- Build costs (allowing for inflation) have been constant for the past twenty years.
- In the past fifteen years, the profit on the average new build house has risen from £6k to £63k.
The caveat in the analysis is that this is the experience of the biggest of the large housebuilders, which have maximised their ability to limit costs through their buying power and economies of scale. The research is based on their published financial statements and a range of other publicly available datasets. It is likely that smaller players are operating in entirely different market conditions.
What is the financial profile of the larger housebuilders?
We have analysed the latest published accounts of all UK-registered housebuilders with total assets of at least £1m, using the analytics within the database maintained by the financial health monitoring specialists, Company Watch. Our research covered 2,859 companies and groups.
We then compared the results for housebuilders with the equivalent data for all types of construction companies with total assets of £1m or more. The summary of our findings can be found here. The headlines are:
- The largest housebuilders are bigger on average than the overall construction cohort:
- Average total assets of £24.3m vs £12.3m for the construction companies.
- Average net worth of £14.1m vs. £5.5m.
- Housebuilders borrow significantly less:
- Gross gearing of 8% vs. 14% for the construction companies
- Net gearing of 15% vs. 32%.
- There are almost twice as many housebuilders in the Company Watch warning area with health ratings of 25 or less out of a maximum of 100:
- 32% vs. 17% for the construction companies.
- There are more than twice as many ‘zombie’ housebuilders with greater liabilities than the value of their assets:
- 12% vs. 5% for construction companies.
- More housebuilders operate with negative working capital, where their easily realisable assets such as cash, receivables, contract value and inventory are less than their short-term liabilities:
- 17% vs. 13% for construction companies.
- Housebuilders’ average overall financial health rating is markedly lower:
- 50 out of 100 vs. 61 for the construction companies.
This analysis must be read in the context of the delays built into the Companies House filing timelines. In effect, the financial statements available in the public domain will be for trading periods up to end of 2022 or the first quarter of 2023. As such they do not yet reflect the setbacks suffered by housebuilders in 2023 because of the impact of the savage rise in interest rates caused by market reaction to the autumn 2022 mini budget during the brief premiership of Liz Truss and other issues.
What happened to housebuilders in 2023?
Statistics from the Department for Levelling Up, Housing and Communities (DLUHC) and from the National House Building Council (NHBC) reveal a sharp reduction in housebuilding activity in 2023:
- New home registrations (when builders declare an intention to build a dwelling) plunged 44% to only 105,449 in 2023 (NHBC).
- New housing starts for the twelve months to September 2023 were 165,990, down 8% on the same period in 2021/22 (DHULC).
- New house completions were 133,213 in 2023, down 12% on 2022 (NHBC).
These figures compare deeply unfavourably with the government’s target of building 300,000 new homes a year.
These falls have variously been attributed to higher interest rates, the cost of living crisis, the planning system and the introduction as from June 2023 of the new building regulatory standards regime.
The impact on financial performance can be seen from the latest results posted by Barratt Developments, who saw their average selling price drop from £323k in H1’23 to £300k for the H2’23, its gross margin fall to 16% compared to 23% in H2 2’22 and profits plunge from £522m in H2’22 to only £157m in H2’23. It is now proposing a £2.5bn merger with its smaller competitor, Redrow. This sort of consolidation activity can often be an indicator of significant problems within a sector.
Prospects for 2024
There is universal agreement that activity levels will pick up in 2024 and that the worst of the inflationary pressures on input costs are past. Mortgage interest rates are expected to ease further later in the year, although the surprise upward blip in CPI inflation for November 2023 is predicted to delay the start of rate cuts by the Bank of England and possibly limit the amount of the reductions.
This should make 2024 a far better year for housebuilders, but the shock of 2023 is a salutary reminder of how vulnerable the sector is to events beyond its control. It will be wise to be mindful of the geopolitical risks of the unfolding crisis in the Middle East and of a year when over half of the world’s population take part in the greatest number of elections ever in a single year.
If you are seeking professional advice for your business, Opus is here to help. You can speak to one of our Partners who can discuss options with you. We have offices nationwide and by contacting us on 020 3326 6454, you will be able to get immediate assistance from our Partner-led team.