Lessons from the Philippines' last real estate surge

As property markets in South-east Asia absorbed major hits following the last time they experienced rapid growth in the late 1990s, questions inevitably arise over the degree to which the Philippines’ ongoing surge in property value and activity is being driven by solid fundamentals rather than opportunism.

Rising household incomes combined with low interest rates and reduced downpayment requirements are creating a surge in the number of first-time home buyers. Yet some analysts have expressed concerns over a supply mismatch, with new developments being geared towards luxury residences over more affordable options, for which there is clear pent-up demand. Drawn by rising prices compared to the returns offered by other asset classes, the wealthier segments of the population could be tempted into purchasing property as a pure capital appreciation play, resulting in those buying to live being priced out of the market.

URBAN COSTS: Vacancies are starting to rise in smaller condominium units (studios and one-bedroom apartments), which could point to developers having overestimated the potential of young business process outsourcing (BPO) workers. “The growth of prices for urban housing has outpaced incomes. As a result, the trend among BPO workers is to lease rooms in the city rather than buy,” Guillermo Choa, the chairman of property developer Pro-Friends, told OBG.

Another perceived area of non-alignment is locational. Most lower-income earners are priced out of the market in city centres. Yet inadequate transport infrastructure and a lack of employment opportunities outside the main cities compels them to live in an urban setting, often informally, rather than buy property in the satellite towns where the government is looking to develop affordable housing.

“To participate successfully in the low-cost housing market, one must adopt building technology that enables fast construction. The government’s affordable housing programme must be centred on the realities of the lower-middle-income market and how it budgets to be successful,” Jesus Atencio, the president and CEO of 8990 Holdings, told OBG.

LAND PRICES: According to research from Colliers, land values reached their highest in 17 years in the third quarter of 2013, surpassing the peaks seen in 1997 when the bubble imploded and the Asian financial crisis took hold. Year-on-year rises in the sought-after Makati central business district were up 12%, compared to 4.5% value appreciations in 2011 and 2012. The average quarter-on-quarter appreciation in the highly desired Fort Bonifacio area was 38.2%.

Rising land values in the more desired commercial districts, where vacant space is becoming scarce, are translating into appreciating capital values. Colliers predicts Grade A office space to yield capital appreciation of 6.8% in 2015, and Grade B to generate an 8.5% return. Yet when discounting prices in real terms, land prices are less than half what they were prior to the global financial crisis. While the margin between appreciation and inflation stays in check– inflation for 2014 is forecast by the Asian Development Bank to be 4% – it is unlikely the market will be subject to any significant speculator activity.

LOCAL DOMINANCE: Walk past a construction site at any of the Philippines’ mall, office or residential projects, and it is likely that the sign will belong to one of the country’s four listed property conglomerates: Ayala Land, Mega World, SM Prime Holdings and Filinvest Land. With large market capitalisations and strong corporate backing from parent and affiliated companies, these firms are easily able to raise capital through equity or debt financing, presenting a challenge for nascent domestic players to compete for projects of the same scope and magnitude.

Only Philippine citizens and corporations or partnerships with a Philippine share of at least 60% are permitted to own land. This, along with stipulations that a foreign national or corporation’s lease agreement is capped at 50 years, may be restricting foreign investment in the sector. According to Jones Lang LaSalle, of the $240bn of investments committed to Asia-Pacific property over the past two years, the Philippines received less than P1bn ($23m). In addition, the IMF feels that the sector’s oligopolistic structure poses some political and financial risk. Most of the entities are family-run, and have on occasion been accused of murky financial dealings and having complex holding structures that preclude transparency. Should debt servicing problems arise, the IMF has warned that this could induce a domestic credit crunch.

INTERVENTION: Corporate governance issues aside, the property boom of the past seven years appears to be driven by solid demand fundamentals, with no definitive signs warranting panic. There remains a backlog for housing in the middle- and low-income segments, as well as for most grades of office space.

Although there is potentially a slight oversupply of premium condominiums, those who are not buying to live can rely on a large and steady rental market from expatriates moving to the country for work, and there is little evidence of flipping taking place. Although most analysts expect prices, uptake rates and the number of groundbreakings for luxury residences to slow, they will likely do so at a pace that corresponds to market correction, rather than a collapse.

The government, nonetheless, is proactively imposing measures to stress-test and mitigate against over exuberant lending and the impact of unforeseen external shocks. Wary of increased exposure to real estate loans, the central bank has capped the amount of lending banks can offer the segment to 20% of their books, while the capital adequacy ratios that financial service companies must adhere to have risen across the board. In addition, in an effort to better monitor the movement of real estate prices, the central bank is introducing a residential property price index in 2015. While direct lending to the property segment is being kept in check, publicly listed developers can still turn to the bourse as an alternative.

PROCEED WITH CAUTION: While fears of a bubble appear to be unfounded, when considering the devastating affect on ASEAN economies of the last major property-driven financial crisis it befits both the industry and the government to show restraint and to proceed with some caution. While the country maintains political stability, and inflation and interest rates hover in a comfortable band, most market and demographic indicators show no reason for concern.

Nonetheless, exogenous and unforeseen events elsewhere in the region have the potential to trigger a contagion effect, as happened in 1997 when the Thai baht collapsed and companies and banks across the region eventually went into bankruptcy.

In addition, there is a risk that local panic could set in if the amount of new builds in the luxury segment leads to a supply glut, causing valuations to fall. This is a particular danger if OFW remittances and investments into the BPO industry fail to keep pace with growth projections. Accordingly, new regulatory measures to shield banks from vulnerability to speculator behaviour are always welcome to help keep both exuberant and reactionary behaviour firmly in check.