Sales are down. Cancellations are up. Share prices are just a third of what they were at this time last year. Few now question that housebuilders face their biggest test since the nineties slump.

Joey Gardiner finds out just how big

The second half of 2007, marked as it was by the failure of Northern Rock, was the most miserable six months the housebuilding industry has known for a long time. And so far 2008 has been even worse: Persimmon is to close offices across the country, major housebuilders are putting the squeeze on their suppliers, and revenue is falling at nearly all the big firms. Investment bank Dresdner Kleinwort put out a research note entitled simply: “Housebuilders: Abandon the sector”. Although some see this pessimism as overdone, there is no arguing with the facts: this time last year Taylor Woodrow was worth £2.45bn and George Wimpey £2.55bn. Today the combined company is worth just over half what either was on its own.

It’s about to get really serious …

The period from the end of January to Easter is traditionally the strongest selling period of the year, which means that we are about to find out if last autumn’s housing market downturn melts in a wave of spring optimism, or deepens to a genuine slump.

And the stakes couldn’t be higher, both for the housebuilders themselves and for the government. According to Citigroup, housebuilders will lose two-thirds of their profits if prices fall steeply. And for the government the situation is just as grave. Gordon Brown has staked his credibility on increasing housing output – the target is to build 2 million homes by 2016. But with all commentators predicting that housing output will fall, these targets are going to get harder to meet.

Roger Humber, strategic policy consultant to the Home Builders Federation (HBF), is in little doubt as to the depth of the crisis. “It’s quite the worst position we’ve been in since the nineties,” he says. “It’s clearly very bad.”

There is plenty of evidence to support his view. Figures collected by the HBF from its members show that the number of firms reporting rising reservations has fallen to its lowest level since 1992.

And it is not just a problem of fewer customers. Once customers reserve properties, they are much more likely to have their mortgage declined by the bank because of the tightening of lending criteria caused by the credit crunch. Mike Killoran, group finance director for housebuilder Persimmon, says this fact has made the number of cancellations rise from 20% to 30% of reservations. “We’re working doubly hard to replace sales that we’ve lost with new sales,” he says.

All the major indices report that house prices have been falling for the past three months, with a further fall of between 0% and 3% predicted for this year. The first figures for January show little sign of bucking this trend – online estate agent Rightmove last week reported prices falling again.

A report by Citigroup in the first week of this year showed just how important these marginal falls in prices are for housebuilders – it calculated that for every 1% drop in house prices, profits fall by 6-7%.

Trends are at least variable according to region and type of development, with sales in London holding up well so far. However, for developers of flats outside the capital, the market has disappeared, along with the buy-to-let investor. Already Taylor Wimpey has been forced to pull its Green Bank development, which would have provided Leeds city centre with 300 flats, and there are rumours that many similar developments are facing a similar fate.

Mark Ryder, the chief executive of public–private joint venture developer Isis, says: “We’re seeing the death of the town centre product that’s become so ubiquitous in the past five years. There are going to be big losers – people who’ve simply built the wrong kit.” And most assume that some companies that bought land or concluded onerous section 106 deals at the top of the market last year will soon be in trouble.

So what should they do?

Housebuilders react to a slowdown in a number of ways (see, David Pretty above), but first they raise sales incentives. Persimmon’s Killoran, for example, says his firm has increased estate agents’ average cut from 3% to 4% of the cost of a home. The HBF reports that more than two-thirds of housebuilders have increased incentives in recent months. They will also attempt to cut costs (see Chain reaction box) and stop buying land. Housing associations will be able to take advantage as builders attempt to flog off difficult-to-sell homes and unwanted land.

The biggest impact, though, will be on the rate of construction. Faced with weak demand, firms concentrate on getting finished homes sold rather than building more. Persimmon’s Killoran says each of his regional teams meets and discusses sales in detail on a weekly basis. They make immediate decisions about whether to slow construction. Citigroup estimate that volumes will fall 10% next year. Humber, though, suggests it could be worse than that. “Starts could go right down to the low of 2003, when we built just 120,000 homes.” To put this in context, that figure is just half the government’s annual housebuilding target, and a 30% fall on last year’s volumes.

In addition, bank-funded developers may face the prospect of having their funding pulled because of the credit crunch. Jim Gill, chief executive of regeneration agency Liverpool Vision, says this is already happening to schemes in the city. “Previously banks have funded schemes on a certain number of pre-sales. But now they’re saying, ‘We’re changing the game, guys’.” Schemes that previously needed to sell 30% of units to secure funding may now need to sell 50%.

Even if funding is no problem, housebuilders may prefer to take their chances with the planning system and try to get a new permission, rather than risk building high-rise flats designed for an investor market that has profoundly changed. Gill adds: “They’re rethinking the mix and scale of development – it’s what you’d expect.”

All of these factors together spell bad news for the government’s housing targets – particularly the move away from city-centre apartments. John Stewart, director of economic affairs for the HBF, argues it has only been by increasing development density that the government has managed to achieve any growth in housing numbers at all since 2003. “The cutback in apartments will have an impact on housing delivery – it’s going to accelerate the problem,” he says. Humber adds that an ever-increasing regulatory burden, particularly with the move to zero-carbon homes, will only serve to make sites less viable still.

But if falling starts is a problem for Brown, for housebuilders it can only mean one: more takeovers. With share prices so low, analysts say that mergers and acquisition activity is likely as buyers seek to pick up good firms at bargain prices. Willmott Dixon’s buy-back of social housebuilder Inspace, as well as Countryside chair Alan Cherry’s mooting the buy-out of the remaining half of the company, can both be seen as indiciations of the shape of things to come. Richard Kelly, a partner at City firm BDO Stoy Hayward, says the only question is how a takeover might be funded in the current financial climate. “What we might see is not trade mergers but the input of overseas funds, such as state-backed sovereign funds, which are looking for good asset-backed organisations. Clearly there are a number of mid-sized housebuilders who are trying to be bought.”

Although nobody denies the long-term demand for new housing in the UK, the credit crunch has clearly posed housebuilders their biggest test in a decade. The next few weeks will give an indication of just how severe that test is going to be. Just don’t be surprised if by this time next year a few more familiar names have become history.

Chain reactions

One of the first things housebuilders will try to do is cut costs. Following the revelation two weeks ago that Taylor Wimpey intended to cut payments to suppliers by 5% with immediate effect, Building asked the top 10 housebuilders if they were negotiating with their supply chains or asking for discounts.

Barratt is understood to be making cuts of up to 5% in payment to contractors. A spokesperson for the firm said its “discussions” were normal business practice in a tight market, but refused to put a number on the cuts.

A letter to suppliers from Bellway struck a more sympathetic chord, as it asked for “help” to weather the tough market conditions. It asked for a “discount” of 2.5% from its supply chain and subcontractors.

Meanwhile other housebuilders, such as Crest Nicholson and Redrow, said they constantly speak to the supply chain to review plans. Persimmon said it had no plans to make cuts – despite the fact it has closed three regional offices. And McCarthy & Stone were even more insistent, telling Building “it is not our policy to dictate anything in terms of pricing or payment”.

In the same vein Lovell said it had no plans for a blanket cut, while Tony Pidgley, Berkley Homes’ managing director, said asking suppliers for discounts was counter-productive and would “upset the labour force”.

If plan A fails …

This year was expected to be a challenging market so the canny housebuilder will have been prepared for tougher times and have plans A and B well in place, writes David Pretty.

Under plan A it will have already tightened its land acquisition criteria, reviewed construction programmes and overheads and got the sales force “match fit” for a competitive marketplace. However, the recent global financial uncertainties, and the effect on consumer confidence, have added another dimension, and the key spring selling season from February through to April will now be a crucial guide to the rest of the year. If the traditional pick-up is weak, you may well see plan B being implemented – a more significant pause in land acquisition and a throttling back of production as housebuilders seek to protect margins by not chasing sales at any cost. All overheads will also be attacked more keenly.

While the fundamentals remain sound and the current “gloom” is overstated, this scenario could be very frustrating for all concerned. The government would see its housing targets under threat just as progress was being made. Many aspiring buyers could be unable to meet new mortgage criteria and thus be unable to fully benefit from a buyers’ market. Housebuilders will also be well aware that any significant and prolonged cutback in land acquisition this year will have a major effect on their production and profit levels in two or three years’ time, when the market is likely to have returned to normality.

David Pretty is the chairman of the New Homes Marketing Board and a former chief executive of Barratt

It’s not bad news for everyone …

Housing associations traditionally do well in a recession, as it gives them a chance to pick up completed homes and land at a significant discount knowing that their income streams from people paying affordable rental rates will remain unaffected, and may even be boosted, by the private sale market turmoil. Derek Joseph, managing director of consultant Tribal Treasury services, says this activity has already started, but so far housing associations have been cautious: “The developers are trying to sell the crap, the secondary schemes – they’re not yet desperate enough to offer really attractive schemes.” Roger Humber, strategic policy consultant for the Home Builders Federation, echoes this prediction. He says: “They’re trying to sell rubbish at the moment but it’ll become very interesting when the majors have to start selling off their decent stuff because they need the money.”

Joseph says associations will be tempted to wait to see if the market gets even better, and to find out how much grant the Housing Corporation has given them when it decides its allocation in April. The Housing Corporation has already let it be known that it is ready to help associations act nimbly to pick up deals. But Steve Douglas, its chief executive, says there is no chance of making more money available than the £8.4bn of funding secured last year.

The only concern for associations is that, with so many now involved in private housebuilding, they could also get hurt by falling demand. They are, however, much more able to insulate themselves against this by simply transferring sale properties to rental properties if demand drops. David Shaw, group development director for Places for People, says: “Certainly we’ll be more buffeted by the market than in the past, but we also have a different business model to the housebuilders. A couple of per cent change in profit doesn’t panic us.”

Slump stats 2

Number of houses sold compared with last year

Barratt –15%
Miller –10%
Redrow –9%
Bovis –6%
Taylor Wimpey –6%
Persimmon –5%