The House Building Benefit Junkies Return
This week’s house builder reporting season provides strong evidence of how government subsidy to the volume house builders is squeezing the smaller builders out of the market and how the subsidy is flowing through to management, banks and shareholders rather than to increasing output.
Companies reported that around 15% of their sales were on government subsidised schemes like NewBuy (notoriously biased in favour of large house builders) and FirstBuy. And that is without accounting for the indirect subsidy from the Funding for Lending scheme which is credited by many with underpinning the growth in mortgage lending.
Interestingly this growth appears to be coming almost entirely from the building societies as the banks continue to reduce their exposure to all things real estate related. We need to keep an eye on the mortgage market because while housing supply remains inelastic mortgage availability is the greatest influence on prices and mortgage deposit levels are currently on an inexorable downward trajectory and starting to contribute to rising prices outside the central London vortex which is currently sucking in its share of the world’s quantitative easing. As the banks’ ungearing ends it is not impossible to imagine that the new Bank of England Governor will need to start thinking about Canadian style mortgage controls in the future.
The statistics also show that the big boys are taking a greater share of publicly funded affordable building and Taylor Wimpey has said it intends to start government subsidised build to rent this year although they have also pointed out that it isn’t viable which presents huge risks for any brave people bidding next week for the government’s proposed licence to run an aggregator vehicle that will raise government guaranteed bonds and on lend the money to build to renters.
All this government subsidy is sending profits soaring. Taylor Wimpey profits were up 106% with the shares up almost 70% this year. And average sales prices are up too.
And in a worrying turn of events the trend for the big boys to buy up the smaller housebuilders to get access to their land banks appears to be returning.
But the number of new homes being built is up just 6%.
The tax payer subsidies are going to repay the banks (who negligently overlent to the sector in the first place – particularly Peter Cummings at HBoS) and to the shareholders who bailed the builders out in the recession when almost all of them were close to insolvency. And it’s also going to go to managers. Bonus payments to some of the top managers in the sector, while housebuilding remains underpinned by public subsidy but not delivering new homes growth, have all the hallmarks of a major scandal.
Companies like Persimmon and Berkeley have put in place, starting in the recession, ten year bonus schemes which give managers enormous rewards for returning cash to shareholders. These schemes have been described as excessive and unprecedented and in some cases to be achievable without any particularly good performance. In a system with weak shareholders, where the management appoints, and pays handsomely, the non executives who sit on the remuneration committees to decide what the management gets paid, it is unsurprising that these situations arise.
In the week when the European Parliament successfully capped bankers’ bonuses at one times salary (two times if approved by 75% of shareholders) and Switzerland is voting on capping all top salaries what are the odds on this happening in housebuilding? I guess it would be hard for them to move to Singapore.
Housebuilding is critical to the economy and to the wellbeing of the nation. Yet without government subsidy it seems likely that the numbers of homes built by the big boys would still be declining as they focus on increased profitability and skimming off the cash for themselves, their banks and their shareholders.
But this isn’t an anti capitalist rant. Some of those dividends are ending up in the hands of pensioners and we need income producing assets to allow that part of our financial system to work although no doubt many pension funds took a bath in these shares in 2008.
Rather it is a plea for government to take a more intelligent approach to restructuring the housebuilding market to encourage the delivery of more homes that are more affordable.
The challenge is how to focus government action on increasing production rather than subsidy leaking out in housebuilders’ bonuses or for banks to deposit with the Bank of England (negative interest rates anyone?).
In the past the answer was always for government to directly finance housebuilding. Not much cash leakage from this approach (apart from the odd bribe by builders to government officials in the Poulson era) as contractors’ margins are closer to 3% than the 20% taken by the housebuilders. And if the housing is for sale (either to investors or to purchasers) then the public investment once made is simply recycled.
The danger of this approach is the horrendous system built concrete towers the public sector gave us in the late 1960s though the current government’s love of the terraced house might mitigate this risk this time around.
If Government was to get into house building (as a number of local authorities are, though mainly on affordable rents) there is a danger of inflating land prices (but by oversupplying local markets government could actively bring down house prices and therefore land prices which the industry never will). Apart from the difficulty of the public sector organising itself to do development (though the housing associations have managed it) there is also the issue of the relative stranglehold the volume boys have on the strategic land market. We need to remember that when the planning minister talks about increasing the amount of greenfield land we build on he is talking about land that is mostly already controlled by the housebuilders. New entrants at scale will always struggle to get hold of land with a reasonable prospect of planning permission.
The volume housebuilders are carrying five or six year land banks of consented land and this excludes their strategic land (green field sites without planning permission) which are many times larger in extent (around 20 times in some cases).
The term house builder has always been a misnomer for this industry. In reality they are land speculators. They option land and work it through the planning process. Most of the profit (and the losses) comes from the movement in the land market during the time they are holding the land. The process of house building is the way of selling plots to purchasers and the margin depends mainly on the amount those plots have cost the builders. This is why profits are currently spiralling.
Now in any rational world (ie one not run by brickies) someone would ask why they go to all that trouble building houses, that the market research shows most people don’t like and won’t buy, when they could just trade plots and allow purchasers to build the home they want to live in. In most of the rest of the world the industry is quite different and most homes are built by Custom Build.
Now a FTSE housebuilder manager that was bright and brave enough to completely change their business model to Custom Build might be worth their enormous rewards.