Q. Housebuilders priced below book value…isn’t that a very strong positive buy signal?
I picked up a comment about many housebuilders currently being priced below book value by up to 20%. Now unless there is some other significant down factor, I normally see this as a very positive buy signal. After all if the company went belly up, that discount would be a safeguard right?
The inference in the comment was that many of these company’s now operating below book were actually quite solid well run businesses that weren’t that stressed given the state of their valuations. So if that is true, why wouldn’t such a company borrow to the hilt and then some to buy back its shares at this wonderful discount. After all, it’s like buying a pound for 80.
A: Well, it could be because those businesses have bought assets – typically land to build on which are expected to fall in value.
As there may be gearing involved, share prices can get quite cheap. Much depends on where the housing market goes, if prices start to rise again, builders are a good buy below book value.
It’s not uncommon for builders to trade below book value, or on very low P/E ratios. They reflect the very real risk of a housing slump, where these businesses can rapidly get into trouble.
As I see it the problem with having too much money in a business is that management are generally not capable of using it wisely. Equally if the company buys shares back near a market bottom then this also helps existing shareholders.
But both actions require good and competent management and most of the time management is so focused on what they are doing in the core business that they have no skill or aptitude for either of the two good options.
For this reason most investors prefer that excess money is given back to share holders. An alternative is to keep it on the balance sheet generating income, but of course this then makes the company attractive to predators and managements never like that feeling.
Q. What are REITS?
A: REITS (pronounced reets) stand for real estate investment trusts and have only launched in the UK towards the beginning of 2007. The aim of REITS is to counter the double taxation of quoted companies, as opposed to direct investments in property.
Like conventional companies, property companies are liable to pay corporation tax and investors in such firms then have to pay tax on dividend payouts. However, direct investment in property only carries one taxation charge which is based on rental income.
REITS offer investors a tax-efficient way to invest in commercial property as REITs are not subject to corporation or capital gains tax as long as -:
-> 1) at least three properties are owned (with no one property being in excess of 40% of the value of the portfolio.
-> 2) the owners do not live in the properties.
-> 3) 90% or more of their profits from rental income is distributed to investors.
Most of the UK’s larger real estate companies like Land Securities (LAND) and British Land (BLND) have converted to REIT status but these companies have been hurt by the downturn of the commercial property so their prices have taken a beating. Since REITS have to pay most of their profits to investors (90% to be exact) they are attractive to would-be investors.
