Who will love the housebuilders now that an interest rate rise in the next two months looks inevitable? Step forward Berenberg, the German bank.
Despite booming house prices and a government that seems to be the equivalent of the US cavalry in those old westerns where the wagons were circled, the sector has underperformed the UK market by around 10% year-to-date.
Concerns about cost inflation, the stamp duty taper, more broad macroeconomic worries and, less plausibly, uncertainty around government support combined to hold back valuations through the summer, according to Berenberg, which noted that the majority of this underperformance has occurred in recent months as inflation rose and the probability of a rate rise increased.
“While housing is undeniably rate-sensitive, we think the impact of small rate rises will be far more muted than the market is pricing in. Demand remains high, pricing continues to offset costs, balance sheets are as strong as they have ever been, valuations are cheap and forecasts achievable, so we are confident that – despite rising rates – this underperformance will reverse,” Berenberg said.
The broker concedes that interest rates do have an effect on house price inflation and after rising incomes are probably the second-most important factor in keeping the house price mania going. Banks are likely to pass on funding rate increases but given current mortgage conditions it thinks spreads are unlikely to widen significantly and should remain at the lower end of their historical range.
Furthermore, higher prices mean higher deposit requirements, and the need to save up for years (or rely on the Bank of Mum & Dad) was the biggest barrier to home ownership before the pandemic; the recent housing market boom in conjunction with lower availability of high “loan to value” mortgages has exacerbated the problem, Berenberg admits.
But…
“If there is an increase in rates, it will be gradual and still well below historical levels. Our economists forecast an increase of just 75bp [three quarters of a percentage point] by Q3 2022, “Berenberg said.
“It is difficult to analyse the impact of previous rate rises on the housing market as they do not occur in a vacuum, but it is mixed at worst,” the German bank suggested.
“Repayment affordability remains well below historical averages and owning is still preferable to renting. Assuming flat house prices, we estimate it would take an increase to c4.8% (from 1.8%) to push affordability (repayments to income) 200bp [two percentage points] above historic averages.
“Wages are expected to grow by 10% by 2024: we compiled wage and house price growth forecasts from multiple sources and, on average, wages are expected to increase c10% by FY 2024; above house prices, which are expected to increase by c8%.
“Higher savings rates could offset higher deposit requirements. While savings rates have declined from their 2020 peaks, they remain elevated and while most do not have a plan for these savings, those that do, plan to save towards a major purchase such as a house,” it added.
Lastly, Berenberg believes mortgage availability is likely to continue to improve, while competition should limit mortgage rate increases.
While a rising tide may lift all boats, Berenberg is neutral on Countryside Properties (LSE:CSP) and The Berkeley Group PLC but just about every other stock in the sector gets a ‘buy’ recommendation, including Barratt Developments PLC (LSE:BDEV) and Vistry PLC, which have both been upgraded, with the price target of the former cut to 810p from 850p previously while the latter’s price target is raised to 1,560p from 1,490p.
Its top picks are Redrow PLC (LSE:RDW) and Vistry while Taylor Wimpey PLC (LSE:TW.) supplants Bellway PLC (LSE:BWY) in the “top picks” list.
