House prices are being fuelled by not only surging demand but also limited supply. Demand the result...
House prices are being fuelled by not only surging demand but also limited supply. Demand the result of 38-year-low interest rates in the UK while supply remains controlled by planning and environmental rules.
This combination has resulted in a rise in the cost of construction and higher profits for building and construction companies. Leigh Harrison, head of UK institutional equities at Credit Suisse, says: 'House building has been relatively positive, we think consumer spending and confidence and a low interest rate means that people will be comfortable taking larger mortgages.
'On the other side, in the building process, planning is taking a long time as there is a shortage of land.'
More houses are being built but the number of these is controlled so that more can be charged, he notes.
This has rendered building and construction companies more attractive to investors. 'The construction sector has performed very well since the tech, media and telecoms boom ended,' says Martin Cholwill, investment manager at Axa IM. 'However, investors were not too keen on the sector because it is not cash generative. A construction business could replace one land bank with another fairly quickly and this would result in lower liquidity.'
Being a fragmented industry, building and construction is now experiencing mergers and acquisitions activities, which is proving to be another attractive feature for investors.
'The increased consolidation within the sector has helped bring it to the forefront of investors minds,' says Eric Moore, UK fund manager at Gartmore. 'The industry still remains a fragmented one.'
Acquisitions have also been a way for companies to cut costs through economies of scale. 'There are a lot of one man bands within the sector but the industry has been consolidating in the past two years in order to achieve better scale benefits,' explains Harrison.
With escalating demand, the cost of construction has been soaring.
The industry is undergoing a shortage of skilled labour, which is pushing wages up and causing wage inflation.
However, as long as demand within the sector remains high and the UK economy does not operate at full employment, there are no real concerns that wage inflation will get out of control. 'There is an issue of labour shortages, but there are no serious threats, with house prices on the rise, companies can afford to increase the cost of labour as well. Inflation is always a threat, but there is no desperate shortage of labour yet,' says Cholwill.
Unemployment would mean that companies can still substitute expensive labour for cheaper ones, giving them some control over wages.
There is at present no bubble in the housing market. Harrison thinks that the economy is in a smoother cycle compared to past cycles.
Moreover the Bank of England is being very cautious to control interest rates in such a way that the economy does not experience inflationary threats. Although interest rates are expected to be on the rise again, the Bank of England is expected to put rates up gradually.
'The sector looks reasonable but it might dampen when interest rates rise,' says Moore.
Demand/supply pushing up prices.
Interest rates remain low.
M&A activity in construction sector.
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