What the stock market thinks about the UK housing market right now

When going about my nefarious business of active investing ^[1], I try to look out for divergences between real-world markets and their stock market proxies.

For instance, gold mining shares were doing poorly long before the gold price really fell from grace.

Similarly, UK housebuilding shares turned down before the house price wobble a few years ago. They came back much sooner, too, as I predicted ^[2] they would.

The list goes on (and is burnished by hindsight bias ^[3], of course!)

One of the most intriguing potential disconnects at the moment is between the stock markets increasingly dim view of the housing sector and – until recently at least – the rabid enthusiasm and commentary about the strengthening economy, low unemployment, and the prospects for house prices, especially in London.

True, house prices have finally come off boiling point ^[4], but the stock market was growing increasingly grumpy about their prospects many months ago.

Now investors seem to believe that the entire UK-wide housing recovery is going back into the emergency ward.

Before considering why and whether it’s right, let’s have a look at a few sectors to see what I mean.

UK housebuilders

The government’s various supportive schemes – together with low interest rates and an economy and financial sector that at least stopped getting worse – did wonders for UK housebuilding shares in recent years.

I wrote ^[2] in November 2011:

The government clearly wants more houses to be built – if only for the economic activity it generates – and most of us seem happy to keep paying an awful lot for those houses. Planning changes should also play into the house builders’ hands.

No guarantees, but I think housebuilders share prices will likely be much more upwardly mobile than general house price inflation over the next few years.

Since the date of that article the major housebuilders rallied between 100-300%. (If only stock picking always worked out that well! It doesn’t…)

However 2014 saw housebuilders’ shares stall or even decline before recovering a bit in the past few weeks, as the following graph from early 2011 to now illustrates:

I’ll discuss below what I think is going on here. The important point though is that positive press stories about UK house prices only really began appearing in 2013 – even in London it was almost a stealth price rally until 2012.

Share prices moved ahead of the market, in other words.

UK estate agents

The recent performance of this sector has been even more dramatic, with Foxtons (LSE:FOXT), LSL Property Services (LSE:LSL) and the much-smaller Winkworth (LSE: WINK) all getting the kibosh in recent months:

This graph goes back to Foxton’s high-profile – and immaculately timed – flotation in September 2013.

Foxtons floated ^[7] at what seemed a heady 230p but the shares still shot up another 20% on the day. In March they touched 400p, but you can now buy them for just 165p.

LSL and Winkworth, which are less directly exposed to the prime London market, have also seen their share prices fall.

UK residential home ownership proxies

Perhaps surprisingly, there aren’t many ways to invest in residential property via the stock market (probably because it’s hard to turf out sitting tenants in a liquidation crisis, though that wouldn’t be an issue for closed-end funds like investment trusts).

Some useful – imperfect – proxies are Mountview Estates (LSE: MTVW) and Grainger (LSE: GRI), which both own substantial portfolios of UK property, albeit discounted for various reasons.

Here’s a graph since 2011:

Grainger is a pretty diversified beast, but over the long-term Mountview is a fairly direct play on the fortunes of London property prices.

The thing to notice here is that Mountview isn’t fair off its highs seen in mid-2014 – and over the year the share price is still well up.

What does it all mean for the UK housing market?

So all you budding Bud Foxes ^[9] (and foxettes), what do you reckon it means?

Is it time to yell “Buy, buy, buy!” into your PC monitor while soberly executing a few online share trades? Or would you be a seller? Should we even reconsider where real-world UK property is going based on these gyrations?

Probably not the latter, in my view, but the share movements do present an intriguing prospect. I’ll tell you what I think is going on, but I’m sure we can have a spirited conversation about it in the comments.

Reasonably people can disagree on, but I have come to believe that the UK does indeed have a shortage of the right homes in the right places. The recent recovery in housebuilding has barely dented this situation, especially when you take inward migration into account.

I therefore think the prospects for housebuilders still remain pretty solid over the next few years, assuming interest rates don’t truly soar or the economy flounder.

So why did their share prices wobble?

I am not convinced it’s a valuation issue. While they’re no longer cheap on a price-to-assets basis, most of the housebuilders still look a steal on earnings metrics. The market presumably doubts the good times can continue for years to come, perhaps because building costs will rise as well as the cost of home buying. This looks a potentially short-sighted view, especially in light of the big dividend policies declared by the likes of Berkeley that might help ward off a boom-to-bust cycle in the sector, as well as underpinning an investor’s returns.

That said, there are shorter-term factors at work, also.

Time to vote

Earlier this year, consensus was moving towards the ‘fact’ that interest rates were about to rise. Well, we all now know what happened there – bond yields have actually fallen!

I think there’s little doubt that this talk of rising rates did hit sentiment about the homebuilders. But tougher lending requirements stipulated by the Bank of England back in Spring has likely had a more concrete impact on the ground.

While the housebuilders have been stressing that their results are only coming off the ‘mega-gang-busters’ setting because it’s hard to improve markedly on last years super-gang-busters results, most do allude to financing being a bit harder for homebuyers to come by.

I noticed too that Bank of England governor Mark Carney said this week as an aside that the housing market had cooled more than he’d expected – or presumably planned for when they moved to cool it. So it is a factor.

Most interesting however – because it’s nailed-on as a short-term factor – is the upcoming UK General Election.

The estate agents in particular have pointed to this as a reason for the market slowing. They blame political uncertainty about, for example, the mooted mansion taxes, as well as wider qualms about whether we’ll remain in Europe. The latter could have a particular impact on the appetite of the foreign buyers who’ve bought heavily in the London new build market in recent years.

The housebuilders have also mentioned the general election as a factor – Redrow (LSE: RDW) and Henry Boot (LSE: BHY) just said in their latest updates that they think local planning decisions will be disrupted for political reasons until after May.

So the housing market does look set to slow – yet at the same time Mountview’s share price might be telling us that investors don’t see house prices falling much as a consequence, even in London.

Potentially then, this is an opportunity to buy the estate agents and especially the housebuilders. A six-month hiatus won’t matter at all to the latter in five years time – and the housing market is one of those where pent-up demand is typically unleashed once the clouds lift.

The picture for estate agents is a bit less clear to me, but their dividend yields look tempting if this is just a hiccup.

Set against all this, house prices in London and the South East still feel toppy. So that curbs my enthusiasm somewhat.

What do you think?

Disclosure: I currently have stakes in Henry Boot and Redrow of the shares mentioned. I’m considering taking stakes in other housebuilders as well as the estate agents.