The Berkeley Group – Effects of the Macroeconomic Environment on Managerial Decisions

The Berkeley Group – Effects of the macroeconomic environment on managerial decisions

The Berkeley Group

The Berkeley Group (BKG) is a leading property developer in the South East of England. In 2015 Berkeley had revenues of £2.12b and delivered over 10% of all new homes in London (Berkeley Group 6, 94)^[1]. In the same year Berkeley won both ‘National Property Company’ and ‘Residential Property Company of the Year’ in the Estate Gazette Awards (Sidders , pg 3). The Group retains a strong financial position, and as of June 2016 was unleveraged and had a net cash position of £107m (Berkeley Group Holdings plc). Following the ‘Brexit’ vote in the United Kingdom, Berkeley faces significant uncertainty in the residential market (Peace , pg 5) that will affect revenue generation for at least 2016/2017. Uncertainty can also mean opportunity^[2], however having a secure net-cash position is not enough to keep Berkeley poised to capitalise on these opportunities in the long term; the company will need to continue focussing on the long-term effects of a rapidly changing global macroeconomic environment when making business decisions.

Supply and demand

The UK is currently experiencing a housing crisis. Although there is a government target to build 240,000 homes per year^[3], the current rate is approximately 150,000 per year (Castella).

Overall there is a shortage in supply of new housing relative to demand. The Berkeley Group operates mainly in the South East of England, and is London centric. Population growth in London has been almost double that of the UK as a whole (Office For National Statistics), further increasing the supply/demand shortfall.

This excess of demand has driven price increases over the last several years and unless supply is greatly increased over current outputs, or demand drops below current requirements then it can be expected that house prices will continue to grow. Longer term revenue projections can be expected to be positive despite current fluctuations being caused by Brexit-related uncertainty.

Price elasticity

With housing seen as a necessity by most people, and with only a limited number of substitutes^[4], prices are generally considered to be inelastic. Increases in demand, or reductions in supply will increase prices. In London and the South East we are experiencing an increase in demand (D1 to D2) with a largely fixed supply (S)^[5] which has resulted in an increase in housing prices (P1 to P2).

[pic 1]

(Spaulding)

However, London also has a very large market for prime residential housing. Being extremely high-value, prime residential housing is almost always a secondary purchase and not considered a necessity. Therefore prices in the prime-residential market show far greater elasticity as other considerations such as taxation, national and global economic factors impact decision making of purchasers.

The Berkeley Group operates in both the ‘normal’ and ‘prime’ residential markets so must continue to be aware of differences in elasticity of prices in the different markets. Given current uncertainty in the local and international markets, Berkeley should pivot away from prime residential towards ‘normal’ residential where price inelasticity can provide greater certainties of revenue.

Market structure

The market structure for housing can be considered to be an imperfect competition. While deregulation of both finance and housing associations, and the move away from government building programmes, has meant that the vast majority of new housing is privately funded by development companies, competition is not perfect.

There are many firms in the market, with a largely homogenous product, however costs of entry are high and there is a significant concentration of the market in a few entities. In 2016 eight firms delivered over 50% of the total number of homes built, indicating that the market has oligopolistic characteristics (Select Committee on Economic Affairs). The UK has a history of opening markets for wider competition, which means the Group should expect greater scrutiny and oversight of operations as housing becomes more and more politicised.

The macroeconomic environment and impacts of mega-trends

While the majority of house builders and house purchasers would consider their activity to be micro-economic, Berkeley Group as a top-ten UK housebuilder by volume^[6] is institutional in size (meso-economic) and can be directly (and significantly) affected by the macro-economic environment. Similarly, being a volume house-builder means purchasers can often be institutional (several units or entire blocks) rather than individuals, and exposure to the prime residential market means that non-market forces from the global economy can impact purchasing decisions.

For instance, recent changes to taxation for buy-to-let and second home owners heavily impacted the Group, due to the reliance on forward sales from these types of investors to finance projects. Change in government regulation to encourage the Private Rental Sector has also made non-market entities direct competitors^[7]. Taxation changes, rising house prices and largely flat income growth has reduced both the number of first time buyers but also increased the average age of home owners^[8] (ONS Digital). As the market reorients towards a greater proportion of renters, use of the “jobs to be done” framework (Christensen) will be required – we are already seeing the effects of people reimagining their relationship to their dwelling from ‘home’ to ‘product’. This effect is changing the types of homes, facilities and amenities that new ‘consumers’ expect in their housing.

Construction is largely site-based, which means our labour force is almost totally UK based. However, due to the significant and sustained skills shortage in the industry, much of our labour force is from the EU^[9]. Similarly, the scale of projects in the Group often requires sourcing of materials from overseas where the local market does not have the expertise or cannot produce the volume required^[10]. Changes in financial and regulatory relationships from Brexit could have a significant impact on our ability to obtain non-UK based labour and purchasers^[11] and could create structural problems in the market. A recent article in The Economist surmised that: