Shift to Houses Helps U.K. Homebuilders Overcome Weaker Market

Margins more than doubled from a year earlier at Barratt
A builder lays brickwork using a trowel and cement on a construction site. Photographer: Chris Ratcliffe/Bloomberg

U.K. homebuilders reacted to the financial crisis by switching from apartments to single-family homes. After a year, the shift is paying off in rising profit margins, helping companies overcome a weakening property market.

The move away from apartments, combined with a 60 percent drop in land prices, may lift operating profit margins in the industry to about 15 percent in three to four years, said Chris Millington, an analyst at Numis Securities in London. That would be the highest since the market’s peak in 2007.

Homebuilders started increasing the proportion of houses, reversing a decade-long decline, after banks cut mortgage lending and the buy-to-let market collapsed. That’s allowing companies to make more money from each sale while targeting buyers who want to live in the property they purchase, instead of renting it out.

Margins more than doubled from a year earlier at Barratt Developments Plc, the U.K.’s biggest homebuilder by volume, as an increase in the proportion of houses boosted selling prices by 18 percent. Sixty percent of the properties it sold in the 12 months through June were houses, up from 46 percent a year earlier, the company said on July 14.

“Houses don’t lock up as much capital as apartments, as you can build them in phases so it doesn’t tie up as much work in progress,” Millington said in an interview.

New houses tend to fetch higher prices than secondhand ones, while that’s no longer the case for apartments. A decade ago, the premium for new apartments was 55 percent, according to property researcher Hometrack. It remains at about 15 percent for new houses.

Planning Changes

Persimmon Plc, the third-largest U.K. homebuilder by volume, earmarked 85 percent of its plots for houses, the company said July 6. In 2007, the level was about 70 percent. First-half operating margins increased to 7.5 percent from 1.5 percent a year earlier, beating analyst estimates.

“Persimmon has a low risk to the high rise apartment market,” Chief Executive Officer Mike Farley said in an interview. “We took the opportunity last year to clear some of our high rise schemes and are focusing on traditional housing.”

At Taylor Wimpey, the U.K.’s second-largest homebuilder by volume, about 23 percent of its land is slated for flats after revising planning and buying land already intended for houses. In 2007, the company got 40 percent of its sales from apartments.

What People Want

“Houses are cheaper to build as you need less steel frames and things, and it’s less problematic,” said Rachael Waring, an analyst at Panmure Gordon from Liverpool. “More importantly, people want to live in houses and not flats.”

The rise in apartment building was driven by a 19-fold increase in the buy-to-let market from 1997 to 2007. That market has been significantly reduced, Waring said.

Widening margins will help the homebuilders stay profitable if the market starts to deteriorate starting in the second half of the year, as some analysts predict.

U.K. house prices will fall through 2012 as the deepest public-spending cuts since World War II and tighter credit conditions deter potential buyers, Capital Economics Ltd. said on July 16. Home values will drop 5 percent this year and 10 percent in each of the next two years, said economists at the research company including Roger Bootle and Ed Stansfield.

Cheap Land

The companies have girded themselves against a slump by adding to their land holdings after the recession drove down prices. All of the publicly traded house builders except Persimmon have sold shares to raise funds for land. Barratt spent 527 million pounds on land in the last year.

Profit margins will increase as builders develop more of the newly acquired land, especially if most of it is used for houses. Barratt said that by 2014, its land bank will be dominated by property purchased since mid-2009. The company bought about 25 percent of its land holdings in the last year.

The forecasts for growing margins may be unrealistic, said Robin Hardy, an analyst at KBC Peel Hunt in London.

“All the modeling for the sector has expected perpetual goodness,” he said in an interview. “If house prices conspire against them, then rebuilding margins becomes increasingly difficult.”

Barratt, Persimmon and Taylor Wimpey have all declined more than 80 percent in London trading since the beginning of 2007. The U.K. benchmark FTSE 100 Index has fallen 12.5 percent in that period.

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