Berkeley Homes produces some of the most desirable goods in the UK. Building high-end houses and apartments chiefly in London, this well-managed company has delivered impressive profit margins and sustained growth.
To explain this success, many would point to London’s chronic housing shortage. Annual demand is typically estimated at 50,000 homes by industry commentators. In stark contrast, an average of fewer than 20,000 houses were actually built each year between 2001 and 2014.
However, this isn’t the full story. Compare Berkeley’s current developments with local area pricing per square foot and the results are striking. On average, Berkeley’s homes in London are selling for a 59 per cent premium compared to equivalent properties within walking distance (400m).
What explains this “Berkeley premium”?
Either Berkeley’s homes are sufficiently differentiated from the rest of the market to justify the extra cost, or they are subject to sources of demand that are not shared with the wider market.
The first explanation is unconvincing. While 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 financial investments and attractive stores of capital.
Indeed, the new-build market is much easier for foreign 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 an unknown individual. In Berkeley’s case, 50 per cent of properties are explicitly bought as investments, with much of the demand coming from international buyers.
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 we need to remain clear-minded about what underpins value creation in our investee businesses.
London’s housing deficit is a long-term and resilient economic trend that we 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, potentially bringing the average price of a London property down as well.