The UK property market is on fire, supported by the dual accelerants of limited supply and low interest rates (although rates are rising, they’re still incredibly low by historical standards).
In this environment, property developers should be flying. Yet shares in some of the UK’s largest-listed developers are in the doldrums. Two great examples are Persimmon (LSE: PSN) and Barratt Developments (LSE: BDEV).
Persimmon recently reported a bumper trading performance for 2021. New home completions rose by 7% to 14,551, and underlying profit before tax jumped by 12.6%.
Meanwhile, Barratt’s net income ticked higher by 2.6% in the first half of its 2022 financial year, even though home completions fell by 11.1% to 8,067 units. A higher average selling price per house offset the lower output.
The two companies also reported bumper forward sales positions, with demand for new properties remaining robust, despite soaring prices.
Despite their booming profits there could be dark times ahead
So why are homebuilder share prices not reflecting these apparent good times? Because the market can see dark clouds ahead.
Builders face many headwinds. Some of these are common to most businesses, such as rising costs, a shortage of workers, and disruption to supply chains. Then, specific to the industry, there remains uncertainty over the cladding scandal and exactly who pays for it. The cost of replacing substandard cladding on buildings could cost the industry upwards of £4bn, according to early estimates.
If there’s one thing the market hates, it’s uncertainty, and these factors are creating a lot of it. That seems to be why these stocks are trading within 10% of their 52-week lows.
I’ll admit, the UK homebuilding sector has been on my radar for some time, as I do love a bargain. However, I’m really uncomfortable with the challenges these businesses may have to overcome in the weeks and months to come.
A better way to get exposure to the UK housing market
Instead, I’d be far more comfortable owning Rightmove (LSE: RMV), which offers exposure to the UK housing market without the challenges associated with investing in the building sector directly.
Buying materials, hiring labourers and building homes is a lengthy, messy and complex job. What’s more, builders need to be able to fund the development until the keys are handed over to buyers. Only when they sell the home can they realise the cash invested in the property. Even then there’s no let up. They have to repeat the process again and again to generate consistent profits.
Rightmove’s business model is worlds apart. The group owns and manages the Rightmove property portal, which is one of the most visited websites in the UK. It also has a large international footprint.
In 2021, consumers spent 18.3 billion minutes in total browsing property on Rightmove’s website and app. That’s equivalent to more than four hours a year for each person in the UK.
A market leader with a growing “moat”
Rightmove has invested heavily in its ecosystem, creating the go-to website for buyers, sellers, renters and landlords alike. In short, if you’re looking to buy a house, sell a house, or rent a house, Rightmove is extremely likely to be one of your first ports of call.
The enterprise has created what US investor Warren Buffett might call a wide and deep “moat” to keep competitors away from its castle.
Houses are essentially just bricks and mortar. Any investor or developer with enough cash and time can start building new homes (yes, before any builders write in, it’s more complicated than that, but you take the point) – but building a new platform to rival Rightmove would take years and billions of pounds of investment.
For example, OnTheMarket (LSE: OTMP), Rightmove’s newest competitor, still only draws in around 300 million views a year, a fraction of its larger peer’s 2.5 billion. It has been trying to grab market share since 2015.
Thanks to the dominant nature of Rightmove’s platform, having a presence on the portal is almost a requirement for estate agents. The company charges each agent a fee for this service, which generates a relatively predictable, recurring income stream. In 2021, 16,110 agency branches subscribed to the service paying Rightmove a total of £225 million, accounting for 74% of overall sales.
This business model means the firm has a certain level of insulation from housing market gyrations. If the market slumps the number of agencies paying to place their ads on the site might decline, but the enterprise won’t have to deal with mountains of unsold stock and bills to pay – unlike the homebuilders.
Rightmove’s competitive advantages justify its high valuation
The only real costs the group has are advertising and staffing costs. These are relatively low as the firm’s huge three-year average gross profit margin of 71% shows. That’s around three-times higher than the building and construction sector average of around 25%.
The company’s return on capital employed (ROCE) – a measure of profitability for every £1 invested in the business – was in the region of 500% last year. Despite the homebuilding sector’s booming profitability, Barrett’s ROCE sits at just 26.8% while Persimmon’s hit 35.8% last year. These are still commendable figures, but they pale in comparison to Rightmove’s profitability.
This high profitability of course deserves – and commands – a premium valuation. The broker consensus on 2022 earnings per share (according to Factset data) is 23.6p. That’s an 11% increase on 2021, putting the shares on a forward price-to-earnings (P/E) ratio of 26.8.
Compared to the homebuilders, most of which command valuations in the single digits, this looks expensive. But these companies are chalk and cheese. A better comparator is Rightmove’s US peer Zillow (NASDAQ: Z). This company is trading at a forward P/E of 70. On that basis, the shares look to me to be a relatively inexpensive way to invest in the UK housing market.