Shares in UK Housebuilders have had a tough year, most having fallen by around 20% so far to trade 12- if not 24-month lows. This has been driven by a combination of fears about a UK housing market which is already showing signs of slowing. But it’s not all bad.

Culprits for this year’s share price declines include Brexit uncertainty and the effects of leaving the EU on the key London/South East of England region. Then there are worries about higher UK interest rates. Remember rates remain extremely low and many borrowers are on fixed deals. If and when the Bank of England (and in turn high street lenders) start raising rates again, refinancing will be more expensive.

In addition, the previously rampant Buy to Let sector has been dented by changes to legislation (e.g. no more deduction of mortgage interest and certain furnishings, higher stamp duty for second purchases), reducing the profitability and appeal of investing in property, resulting in less speculative buying and more For Sale boards as investors cash out.

On the flip side, with housebuilder dividend yields inversely related to share prices, as share prices have fallen these have risen (inverse relationship). This has gradually offered investors even higher income for taking the risk of being exposed to UK builders. In some cases they have annual dividend yields over 10% (Bovis); at worst they offer 5% (Bellway). Rather competitive versus what the banks will offer for cash on deposit.

So all is well. Well, not quite. Obviously that 10% yield is only available if you buy the shares now. If you had bought the shares at the turn of the year, your yield would be 20-25% less because it’s based on your entry price (7.5%/8%; still very nice). And you would of course be sitting on a share price decline of 20-25%, which even these high dividends would take 2-3 years to make up for.

Today might appear an even better time to buy UK Housebuilder shares, to capitalise on those chunky yields. However, consider this: what’s the difference between now and the turn of the year. Those 7.5-8% yields looked just as exciting back then. Buying today, you’d essentially be saying that all the bad news has already been “baked” into housebuilder share prices, and declines will not exceed the dividend over the same period. Given the aforementioned headwinds that’d be quite a call. Some question whether those dividends are even secure. What if you bought the shares and the company cut the dividend? It does happen. It’s the last thing companies want to do, to keep you on board, but if they have to cut it to preserve cash, they will.

Which brings me to my last point, ahead of the Chancellor’s UK budget next week. Another factor that has helped UK housebuilders and the UK property market, along with low interest rates, has been government stimulus programmes such as Help-to-Buy. So far the government has committed almost £9bn, boosting the deposits of 169K buyers so they could purchase over £40bn of bricks and mortar.

But after five years, the scheme’s days could be numbered. Last October the PM pledged another £10bn of assistance through March 2021. With the property market slowing, however, and at this political juncture, the risk of extending yet another stimulus programme that has inflated asset prices, in turn risking exposing more of the population to falling prices and rising costs, is a difficult one to reconcile politically.

But if the punch bowl is removed……remember how global financial markets panicked about the end of the US bond-buying stimulus programme known as QE. Any hints about the first steps towards scaling back the Help to Buy programme next week would certainly be bad news for housebuilders (e.g. less incentives, restrictions on price/loan amounts). Having committed to 2021, an earlier end-date would be the worst case scenario, and surely risky for the government. Even a firm end date beyond 2021 would still dent the outlook. The only thing that would help housebuilders next week would be an extension of the current generous set-up beyond 2021.

The likelihood is we get something in between; an extension, but on less generous terms. The longer the extension, the more the shares should like the extra help. The less generous the terms, the more they feel the Help-to-Build has run its course. Whatever the outcome, it is the current uncertainty which is weighing. Knowing will at least remove a cloud from the shares and let us know whether the shares are indeed a bargain, and whether those enticingly generous dividends can be assumed going forward.

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Mike van Dulken, Head of Research, 26 Oct 2018