Merrill Lynch calls UK housebuilder sell-off 'overdone'

18th Jun 2014 16:19

Bank of America Merrill Lynch believes the sell-off in UK house-builders has been "overdone" and that there is a "pent-up rally" lurking, citing several historical examples to suggest the sector setback is only temporary.Merrill analysts insisted that rising interest rates, or just the fear of them, "does not imply that the UK House Building sector will go ex-growth or that it cannot perform strongly in a relatively benign rising interest rate environment". The only scenario that would worry them is if mortgage rates push through 5% compared to the current 2.73% rate on a 75%-loan-to-value two-year tracker mortgage, which is not a likely scenario in the short term.In the last cycle, back in late 2003, the first rise in interest rates was met with underperformance that was short-lived, it is noted, while the year-end saw the sector 1% higher than it had been a month before the rate rise. In the following three calendar years the sector rose 20.5%, 43% and 29.8%, the broker recalled. According to data from the Council of Mortgage Lenders, mortgage interest costs as a percentage of income are currently much lower than the middle of the last cycle. "Therefore, with house prices outside London 2.5% lower than peak, it would appear that rates could move materially higher before interest costs approached historical levels."Due to the annually cyclical nature of the sector - being strong from December through to March and weak the rest of the year - a potential interest rate rise in the fourth quarter "could remove any lingering doubt about timing and coincide with the seasonal performance pattern".All considered, the broker remains positive on the sector, with favoured picks being Taylor Wimpey and Barratt Developments, both "cheap".PW