Housebuilders partied like it was '89. And now the pain is like '91
Housebuilders ploughed on with their growth plans at the top of the market and now they're paying the price, finds Mark Leftly
Sunday 06 July 2008
Once again, Tony Pidgley, the Barnardo's boy turned multimillionaire residential builder, is set to make a killing out of a property downturn. While his peers at Barratt and Taylor Wimpey were getting ready to announce mass redundancies and desperately trying to shore up their balance sheets in the worst housing crisis since the early 1990s, the 60-year-old chief executive of Berkeley announced two weeks ago that the company would spend £350m on cheap land.
Berkeley board members had noted a 25 per cent fall in land prices, so decided to go buying in a move that in effect calls the bottom of the market. Pidgley made the same call in 1991, making him something of a legend in the close-knit world of housebuilding. "By and large the reaction from our shareholders has been first class," says Mr Pidgley, with the biggest of smiles. "The vast majority of them trust the management."
Investors in housebuilding's "big three" – Taylor Wimpey, Barratt Developments and Persimmon – have been far less trusting: their share prices have all lost more than 80 per cent of their value in the past year.
For Mr Pidgley, the game is simple: a decade of uninterrupted growth should have meant that builders had enough cash stashed away for the fall that was bound to occur in such a cyclical industry.
"The City pushes for more and more – turnover growth, profit growth – and it rewards managers if they achieve that," sighs a source. "But the industry is not scaleable; housebuilding needs discipline."
Mark Clare and Peter Redfern, the chief executives of Barratt and Taylor Wimpey respectively, believed that the industry was scaleable – that it was ripe for consolidation. Last year Barratt bought rival Wilson Bowden for £2.2bn, while Taylor Woodrow and Wimpey merged, creating two FTSE 100 forces.
Former directors at Barratt were not convinced by the strategy; the company hadn't made a big acquisition in two decades. Last week their doubts only grew stronger as the company, burdened by £1.7bn of debt, announced 1,000 people would go from its 6,700-strong workforce.
Leslie Kent, a director and analyst at broker FinnCap, says Barratt's decision to buy Wilson Bowden at the top of the market has caused its current plight. "It paid 22 quid for every 11 quid of assets," he points out.
The falling values of those assets and the decline in house sales meant Barratt was in serious danger of breaching its banking covenants. However, a trading statement this week is expected to confirm that Mr Clare has managed to find £400m of fresh debt to help finance repayment of the Wilson Bowden acquisition. He should also announce that he has negotiated a relaxation of Barratt's covenants.
Taylor Wimpey's problems run even deeper. On Monday the board confirmed speculation it had changed the terms of its credit facility – on the condition it raised equity. By Wednesday this capital raising was in chaos when a trading statement reported that negotiations with investors had not led to "a satisfactory transaction". If the situation is not resolved, or house prices don't rise dramatically, Taylor Wimpey will next year find itself in breach of "one or more" of its banking covenants, the statement added.
"The Taylor Wimpey stuff is really scary," says a property banker who is also a veteran of the 1990s crash.
Mr Kent at FinnCap adds that Taylor Wimpey's woes have been exacerbated by the way in which the merger was completed. Under accounting rules, one party had to be viewed as the acquirer and Taylor Woodrow was accorded that honour, with the result that Wimpey's land bank was valued at 2007 prices. As this was the peak of the market, that value have since fallen heavily, hurting the balance sheet.
"Builders that haven't made big acquisitions will find their land revaluations will not be in the same order of magnitude," says Mr Kent, before hinting that this won't necessarily protect their share prices. "The stock market takes no prisoners; all housebuilders are tarred with the same brush."
Paul Pedley, a former chief executive of housebuilder Redrow, believes "the market took a step forward in 2006 it perhaps shouldn't have". In other words, there should have been a correction that would have created "a soft landing". "Mortgages were at low rates and there was a lot of corporate- financed growth," explains Mr Pedley. "This allowed housebuilders to carry on growing in 2006-07. It was like having a couple of drinks, then deciding to have four or five."
The result, with the hammer blow of the credit crunch, is a very bad hangover. This collapse has taken place in nine months, compared to four years in the 1990s. Worse still, the housebuilding industry is far less nimble than it was in 1989-92, so it will take companies longer to alter their tactics.
Mr Pedley blames the Government's Communities Department for this. In the 1980s and 1990s, the housebuilder's model was to construct detached and semi-detached homes. Since 1997, the Government has looked to tackle the UK's lack of housing by making developments a lot denser – terraces or lots of flats.
Before 1997, developments could be stopped halfway through as individual houses could still be quickly completed and sold. But builders cannot stop when they have constructed only half of a 50-apartment block. "We could turn the tap off quicker back then," explains Mr Pedley. "We've done what the politicians asked, and now we've got the problems."
But that lack of supply is the one ray of hope for likes of Barratt and Taylor Wimpey. Underlying all the chaos is a need for at least 250,000 new homes a year. In the long term, the Government will have to address this, even if that means providing more funding to banks so they can offer better-rate mortgages.
Peter Alcaraz, head of housebuilding corporate advisory work at Close Brothers, sums up this point: "This is an affordability issue. There is a lack of access for funding for buyers, so there is a slowdown in the number of housing transactions."
However, until those mortgages are made available, housebuilders will face a nastier version of the early 1990s. Perhaps next time, they will follow the lead of the Barnardo's boy.
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