An improvement to build on: The market for new housing is picking up, writes Heather Connon

AS predictable as the first daffodils, Britain's housebuilders are reporting a flowering in the housing market. Queues of buyers anxious to sign up for homes have been reported at sites as far apart as Kent and Aberdeen; a confidential survey of 15 of the top housebuilders revealed a 20 per cent rise in sales over the first two months of the year.

But we have been here before. The flurry of activity sparked by the end of the Gulf war two years ago quickly evaporated. Last year, builders were optimistic that a recovery in the early part of the year would strengthen when the uncertainty of the election was removed; instead, the market plunged into a further downward spiral.

Housebuilders, having been caught out too often in the past, are wary of calling the bottom of the market just yet. But that does not stop them pointing out that buying a house is more attractive than it has been for years. Certainly, mortgage rates are at their lowest for more than a quarter of a century, with some lenders offering fixed-rate deals at 5 per cent. The fall in house prices since 1989 - by as much as 30 per cent in some areas - has made houses more affordable and buying cheaper than renting for the first time since the market peaked.

But falling house prices have also caused one of the market's big problems: negative equity, which affects 1.7 million people, or 17 per cent of all mortgage holders. That, plus the fear of redundancy - which is likely to remain a real threat for at least the next 18 months - is a powerful disincentive to prospective puchasers.

Investors are clearly anxious to shrug off such concerns. Builders' shares have risen by more than 10 per cent since the start of the year, outperforming a buoyant market by 4 per cent. But confidence is fragile; neither housebuyers nor investors will take kindly to unexpected shocks.

The first of these could come at the end of the month, when the pounds 750m provided by the Government to mop up some of the housing surplus runs out. According to the Housing Corporation, which is administering the distribution of pounds 577m of the package, about half of that - equal to 9,135 homes, or more than the 8,700 new houses completed by the private sector in January - will be used to buy new houses.

Persimmon, which said last week that sales since the start of the year were up by 30 per cent, admits that a third of the increase is due to sales to housing associations. Virtually all the other big builders - including Wimpey, Barratt Developments, Y J Lovell and John Laing - have benefited from the scheme.

Housebuilders say that sales are still running ahead of last year if association business is excluded. But as association business is likely to be at low - if not negative - margins, the increase in volumes will do little to improve profits.

The second question mark over the recovery is whether builders are comparing like with like. Many of the smaller housebuilders have been expanding their activities as the larger ones retrench. Bellway reports a 50 per cent rise in sales, but it is operating from a larger number of sites. That means increased overheads and, unless sales increase proportionately, profits will be squeezed.

The market would also be unsettled by a repeat of the flood of rights issues two years ago. Already, there are signs that builders are cashing in on rising share prices, with Bellway and Berkeley asking for pounds 33.6m and pounds 44m respectively.

The sector's rights issue record is not good. Shares in many companies that asked for cash two years ago - including Taylor Woodrow, Amec, Costain and John Mowlem - languish far below the rights prices. They have since slashed their dividends, and some urgently need a further cash injection.

But investors are being much more selective about where they put their money. They are shunning companies with large exposure to contracting, where demand is expected to continue to fall well into next year, and are instead looking for companies with the management and financial muscle to expand in the housing market - such as Berkeley, Bellway or Wilson (Connolly).

That rules out many of the larger companies - many of whose shares are so depressed that a rights issue would be prohibitively expensive.

The housing market has been in the doldrums for more than four years, so recovery is already long overdue. But the impact on builders' profits should not be overestimated. Most companies spent far too much buying land at the top of the market. Although there have been heavy provisions on this land, they merely allow the companies to break even when it is built out and sold.

House prices are also unlikely to recover as quickly as volumes, so that margins - already about half their peak - could remain depressed for some time. However, recovery could reduce the need for incentives that, according to Persimmon, have pushed average selling costs up from pounds 1,500 to pounds 5,000 a house.

If the builders are right - and there are signs that this recovery is more solid - there will eventually be money to be made in housing. But the message to investors is: choose your company carefully.

(Photograph omitted)