One of the best performing sectors in 2014 and 2015 was the house building sector; however 2016 has proved to be a much more testing year for a sector that suffered more than most in the wake of the financial crisis in 2008.

After gains in excess of 200% to 300% in the years since 2011 there was always a feeling that a period of consolidation was probably well overdue.

This feeling was even more acute at the end of last year given concern that the measures taken to change stamp duty thresholds introduced in 2014 could well start to slow the housing market, and thus open up the prospect that valuations might well be a little bit expensive.

This does appear to have been the case in 2016, particularly in London and the South east, particularly since the additional stamp duty charge for a second property or “buy to let” properties came into effect on the 1st April this year. We’ve also seen the sector take a hit in the wake of the June Brexit vote, though the price declines haven’t helped make properties any more affordable to the lower end of the market.

What they have done is compress the upper end of the market while underpinning the bottom end, pushing up prices in the process, thus eroding supply even further.

In its recent Autumn Statement the government pledged an extra £3.7bn towards housing in the form of £1.4bn for affordable homes, and a £2.3bn infrastructure fund for 100,000 new homes.

This was in addition to previous pledges to increase subsidies to private developers, housing associations and local authorities, in order to help meet a government target of 1m new homes by 2020, though all the money in the world won’t be of much use if there aren’t enough construction workers available to build them.

This raises the next big concern around the sector which could well be a sharp rise in labour costs due to the lack of skilled labour, as house builders struggle to build houses quickly enough, and this is likely to be a recurring theme going forward.

The latest RIC’s UK construction survey showed that the industry is facing a big skills crisis, with 51% of respondents saying skills shortages were a constraint on growth, with surveyors and bricklayers in particular in short supply.

This gap could widen if the government is successful in getting its various infrastructure projects off the ground like HS2, Crossrail 2 and airport expansion off the ground, in the process creating a huge bidding war for these sorts of transferable skills.

The CEO of Taylor Wimpey Peter Redfern recently estimated that 12% of the company’s work force came from the EU. This shortage more than anything else could well be a headwind to the UK housing sector and homebuilder’s future margins.

Source: CMC Markets

These uncertainties do appear to have prompted a re-evaluation of the sector however in terms of the overall numbers it is interesting to note that the losses this year have been manageable particularly in the context of the gains seen since 2012.

While Barratt Developments is the worst performer year to date, down around 25%, in terms of revenues and profitability the company is still on track to grow its revenues, though its profits do appear to be showing signs of plateauing.

Revenues in the year ending June 2016 came in at £4.2bn with pre-tax profits of £682m. In its most recent trading update the company was upbeat with more sites under development than the same period last year, saying demand for new homes was strong, however in London it was looking at lower prices in the region of about 5% to 10%.

Persimmon shares have also given up a small proportion of their triple digit percentage gains since 2011, but like Barratt are starting to show some signs of consolidation, against a backdrop of concern about stretched valuations.

The company appears to be on course to post an increase in both revenues and profits on its 2015 tax year. Estimates are for revenues of £3.1bn and pre-tax profits of £749m for the year ended December 2016, with the most recent trading update showing that consumer demand remained strong.

In a nod to concerns about skills and materials shortages the company also announced plans to commission a new brick factory at a cost of £10m, near Doncaster in an attempt to address concerns about a lack of supply.

Both companies both pay a decent dividend and appear to have sufficient dividend cover as well which makes any future share price growth a play on not only the construction sector, which has held up fairly well since the summer Brexit vote, but also on the companies operating margins.

It’s been a familiar theme from the rest of the UK house building sector with Taylor Wimpey also reporting a similarly upbeat view of the UK housing market last month, with forward order books up on the previous year, to £2.3bn from £2.1bn, though the London market was a weak spot.  

With unemployment at multi-year lows and skills shortages unlikely to be plugged quickly unless by immigration, then the ability of house builders to build the houses required is likely to be constrained, not by money, but by head count.

The big question when we looked at this year was whether we could see further gains in a sector where recent price moves were becoming a little stretched. This was clearly visible a year ago on a long term weekly chart of price action relative to the long term 200 week average, where prices were between 50% and 70% above their long term averages.

Bloomberg UK homebuilders index

Source: Bloomberg

This is no longer the case, as can be seen above; which means in 2017 we need to see a fresh move back to the recent highs. Unfortunately the price action since those peaks hasn’t been particularly encouraging in terms of signalling the prospect of strong future gains.

For most of this year each downward thrust has been followed by a weaker rebound and as such having found a base in the aftermath of the recent Brexit vote we need to see a strong move through the September peaks at 530p, while holding above the long term 200 week MA.

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CMC Markets is an execution-only service provider. The material (whether or not it states any opinions) is for general information purposes only, and does not take into account your personal circumstances or objectives. Nothing in this material is (or should be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by CMC Markets or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person.