When considering an investment in a company, it is important to understand what really drives demand for the company’s products, even if demand trends may appear incredibly robust and obviously explainable.
Berkeley Homes produces some of the most desirable goods in the UK. Building high-end houses and apartments chiefly in London, this very well managed company has delivered impressive profit margins and sustained growth. Many would point to the much-publicised housing shortage in London to explain Berkeley’s success. But a closer look reveals a potentially dangerous reliance on speculative property buyers1.
The chronic lack of supply and excess demand for housing in the UK, especially in the capital, features regularly in the national press, and has played a prominent role in political debates surrounding both the 2015 General Election and this year’s London Mayoral Elections. 50,000 homes per year is the oft-quoted figure that industry commentators cite as London’s annual ‘demand’ for homes, with less than 20,000 actually built on average between 2001 and 20142. Given this ongoing concern over a housing shortage, it is tempting to view Berkeley’s high revenues, profits, and returns as well-earned rewards for supplying an underserved market. Few expect these favourable market dynamics to change anytime soon, meaning there is little reason to question the sustainability of Berkeley’s record profits.
What price would you pay for a new build home in your local area? I suspect most people would expect similar pricing to their own home, or perhaps a small premium to reflect newer more reliable build quality.
In the table below, I have compiled a list of Berkeley’s current developments. The table shows the price per square foot and compares this to the local area pricing. The results are striking: Berkeley’s homes on average are selling for a 50-60% premium, adjusted for size, to equivalent properties within a very short walking distance (400m).
What might explain the existence of this ‘Berkeley premium’? I see two possible explanations. Either Berkeley’s homes are sufficiently differentiated from the rest of the market, or they are subject to sources of demand that are not shared with the wider market.
The first explanation is unconvincing. Whilst Berkeley does build quality homes fitted out with higher-end interiors, it seems unlikely that marbled bathrooms and wall-mounted televisions can explain a premium that often runs to hundreds of thousands of pounds, irrespective of size and location.
The second explanation is more persuasive. New-build London homes are marketed worldwide as a financial investment and attractive store of capital. In Berkeley’s case, 50% of private sales are explicitly bought as investments, with much of the demand coming from international buyers3. Additionally many properties bought for occasional use – children studying in London for example – have a strong investment character even though they may not be recorded as such.
The new-build market is much easier for foreign investment capital to access. Developments are marketed abroad at roadshows, products are more standardised and buyers trust that they are transacting with a large reputable company as opposed to a potentially unreliable individual seller.
For many international buyers, the attractions of an easily accessible and strongly rising property market may justify the premium paid, or they may simply be unaware that the premium even exists.
Thus far, Berkeley Homes – and others – have profited considerably from servicing the demand for housing as a financial asset rather than an economic good. Even without addressing the resulting social implications of this strategy, as equity investors it is important to remain clear-minded about what underpins value creation within businesses.
London’s housing deficit is a long term and resilient economic trend that I expect to continue, but the speculative international demand for investment property is altogether more opaque, complex, and potentially volatile.
If this source of demand were to falter or reverse – as a result of a Brexit, or continued slowdown in China perhaps – the value of Berkeley’s homes would then be determined by the supply and demand fundamentals of those who actually live and work in London.
The reality of such a new dynamic would inevitably cause both Berkeley’s premium and its profits to shrink considerably, and potentially bringing down the average price of a London property along with it.
This is no recommendation to buy or sell any particular security
1. Evening Standard for 50k figure http://www.standard.co.uk/news/london/london-housing-shortage-one-of-britains-biggest-public-policy-failures-of-the-last-50-years-10325256.html
2. GLA report for houses built https://www.london.gov.uk/sites/default/files/housing_in_london_2015.pdf
3. Source: UBS research report