We expect net housing supply to slow down in the short term due to the economic headwinds (consensus view of -0.4% fall in GDP in 2023). However, we think the housebuilding sector is in a far more resilient position than in previous recessions. While development volumes are likely to be disrupted over the next 18 months with lower levels of activity, we expect continued demand for both new homes and, therefore, development land in the medium to long term.

The major housebuilders

The major housebuilders are in a much stronger financial position than they were in 2007/08. Housebuilder annual reports for 2007 showed that the listed builders were carrying a cumulative net debt of over £3 billion. This high level of debt, coupled with larger amounts of standing stock created a need for developers to sell quickly, and led to falls in new build values before the downturn in the wider market.

The most recent annual reports show a strong reversal of this position. The listed housebuilders have an average net cash position of £690 million. While total liabilities are now 13% higher than in 2007, this has been offset by a 1,057% increase in turnover. In 2021, liabilities as a percentage of turnover were -53%, whereas in 2007, they were -554%.

In 2007, the top nine PLC housebuilders made £267 million in profit, but by 2021 that had increased tenfold to £2.8 billion. This is in part due to house prices growing by 45% across the UK since 2008, far outstripping the rate of growth in the land market. As a consequence, the major housebuilders are in a considerably better position to manage price falls or a slowdown in sales than they were during the global financial crisis (GFC).

Build costs are likely to be the primary challenge for housebuilders. Since the middle of 2021, build costs have been rising at their fastest sustained rate since prior to the GFC. The impact of freight delays from lockdowns in China has exacerbated price rises caused by the energy crisis, supply shortages and high demand from infrastructure projects. In their trading updates in 2022, the major housebuilders commented that build cost inflation had been offset by house price inflation which was roughly the same level (between 8–10%). However, with house price falls forecast over the next year, these rising costs will no longer be offset, and will add to downward pressure on land values.

Small and medium enterprises (SME) builders

While the major housebuilders are in a strong position to weather market uncertainty, many smaller developers are likely to find the coming year much more challenging. Data from the Federation of Master Builders State of Trade survey suggests that this part of the sector is most affected by the rapid rise in inflation. 98% of survey respondents reported an increase in costs in Q2 2022, and 71% reported that a lack of materials was delaying jobs.

These material cost increases will be compounded by the rising cost of development finance following September’s mini-budget. Even in 2021, the FMB’s Housebuilder Survey reported that 45% of respondents had sites that had stalled for finance-related reasons, and a third of firms cited a lack of finance as an anticipated barrier to development over the next three years. These proportions are likely to have risen sharply since the 2021 survey; as these developers typically seek development finance on a project-by-project basis, they will be hardest hit by the sharp rise in base rates and borrowing costs. As a consequence, this part of the sector will contract, and we expect smaller developers to be significantly less active in the land market over the next 18 months.

However, some SME housebuilders have been supported by private equity with significant growth strategies and therefore are in a stronger position to weather the market slowdown.

Housing associations

Housing associations (HAs) have delivered or funded an average of 22% of all new housing completions over the last five years. The longer-term nature of the current Affordable Homes Programme has given HAs the ability to plan for a strategic development pipeline, and as they are less exposed to the wider housing market they may be able to continue with planned delivery targets over the next five years.

However, there are concerns across the sector around the proposed cap on rent rises that the government has recently been consulting on. In an attempt to protect tenants from soaring costs, the Government is consulting on capping rent rises in social housing at 3%, 5% or 7%, rather than the current cap of CPI plus 1%. This would cut their operating surplus by between 11% and 31%. When the sector last saw rent rises restricted through the Welfare Reform and Work Act in 2015, HAs had to cut costs, including through reorganising repairs and maintenance programmes. The Regulator of Social Housing concluded that the reduction in service for tenants was unacceptable. Facing income pressure again, it is likely many HAs will focus on core services for existing tenants. To do so, they may temporarily pull back from development activity that is not fully funded by grant.

Outlook for the land market

The development land market has enjoyed an exceptionally strong last two years, with a 13.8% growth in greenfield values since September 2020. This has been accompanied by high levels of activity, with landowners seeking to take advantage of a strong market, and developers seeking to replenish pipelines off the back of strong sales rates. However, nationally, land values are only just back to their 2007 highs, and the rate of growth over the last two years has been 17% slower than in the two years prior to the 2007 peak.

Despite the downturn in the housing market, we expect to see continuing demand for development land, and do not expect price falls on the scale of the -55% falls seen in 2007/08. With the major housebuilders in a stronger financial position, there will not be the pressure to write down land and sell sites cheaply that there was during the GFC.

There will however be an adjustment in land values in 2023. The prospect of house price falls and reduced transactions will bring land values under some pressure. While developers were prepared to compromise on margin earlier in the year to secure sites, we anticipate they will now be raising land buying hurdle rates, restricting what they are prepared to pay for land and putting downward pressure on values. However, given the strong price growth of the last two years, even -10% falls would take land values back to 2018-19 levels, and therefore there should still be enough incentive for landowners to continue to bring sites to market.

Given their strong cash positions, we expect the major housebuilders to continue to buy sites, albeit more selectively, competing for the best oven-ready sites. Activity from SME developers and HAs are expected to fall, as higher debt costs make these organisations less able to compete in the market. The exceptions will be those who have agreed a debt facility prior to September 2022, or those benefitting from private equity investment. According to the FMB survey, private equity is now the primary source of finance for 41% of SME developers.

We also expect land buying to become more selective. The major developers are returning to prioritising sites with capacity for 100–200 units, whereas, earlier this year, many would have considered sites below 50 units. Sites with high upfront infrastructure costs or outside of core operating areas are likely to have less demand.

However, the best sites will remain in demand due to the lack of supply coming through the planning system. The number of consents granted in England in the year to June 2022 was 281,000, the lowest annual total since March 2016. This shortage of supply is likely to limit falls in value over the next 18 months, and the high level of underlying housing need means that values should return to growth as the cost of debt begins to fall in the second half of 2024.