The Philippines: Waiting for the REIT stuff

With interest rates still low and consumer demand strong, the Philippines real estate sector is off to a good start this year. However, continued delays in implementing the legal framework for real estate investment trusts (REITs) may slow momentum in the property market.

According to data released in early April by the Bangko Sentral ng Pilipinas (BSP), the country’s central bank, outstanding loans by commercial banks increased by 12.3% year-on-year (y-o-y) in February, up from the 11% recorded in the previous month. Moreover, lending to the real estate, renting and business services sectors expanded more quickly than the average, with y-o-y growth of 16.9% for February.

Growth during the first two months of 2011 continues a trend that was set in 2010. According to the BSP, residential real estate loans as of December 2010 were 15.8% higher than the previous year and accounted for 39.9% of all consumer lending in the fourth quarter of 2010, a small increase over 2009.

This expansion in 2010 may have been due, at least in part, to the BSP’s low interest rate policy, which saw set at 4% in July 2009 and remain unchanged throughout 2010. Many commercial banks responded by offering housing loans with favourable terms, in some cases with interest rates as low as 5.75%. However, the central bank has already raised the policy rate once this year – to 4.25% in March – and it could do so again in response to inflationary concerns.

While banks and investors are expected to continue to channel money into the sector, one potentially important vehicle for investment – the REIT – is not yet an option for those looking for opportunities in the Philippines real estate market. In 2009 legislation was passed that would allow the establishment of REITs, and the Securities and Exchange Commission (SEC) subsequently issued draft rules for implementing the law. However, thanks to differences between the SEC and the government’s Department of Finance (DOF), the REIT law has yet to be finalised and put into effect.

One point of contention has been the minimum public float that would be required by law. The SEC initially proposed that a company could establish a REIT by listing just 33% of its shares, but last year the DOF requested that this be increased to an initial minimum of 51%, growing to 67% public ownership within three years. However, in February 2011 the finance secretary, Cesar Purisima, told reporters that the DOF would accept a minimum of less than 51%. Subsequently, the commissioner of the Bureau of Internal Revenue (BIR), Kim Jacinto-Henares, disclosed that the DOF would be willing to allow a REIT to sell an initial 40% of shares, building up to 60% within three years.

According to Purisima, such minimums are necessary to increase the amount of capital being utilised and generate more economic activity, as he said in an interview with news station ANC on April 28. “There must be a programme to accelerate the recycling of capital because the logic for the creation of the REIT is not the elimination of income tax. It is the recycling of the capital,” Purisima said. “The elimination of the income tax is just to give them the incentive to recycle capital.”

Indeed, because REITs are entitled to tax incentives, the DOF has also expressed concern that their implementation would potentially reduce state revenues. To counter such losses, the department has proposed imposing a value-added tax (VAT) on the transfer of assets into REITs. In February 2011 Jacinto-Henares said that the BIR was planning to impose a 12% VAT on such transfers, but the agency has yet to issue any rules on tax incentives for REITs.

If the path to REITs were cleared, it could potentially raise the profile of the country’s real estate market for overseas investors, says fund manager Brett Gordon, the founder of Hong Kong-based Panna Capital. “The implementation of the REIT law in the Philippines is also going to be very interesting,” Gordon told a seminar in early April. He explained that, while the law had been delayed for some time, he would expect to see a “growing institutional market for real estate in the Philippines” if the law were to come into effect.

Until the various public and private interests sort out their differences, the upside to introducing REITs will remain only theoretical. Even without them, however, solid demand will keep the real estate market moving along, although growth may fall short of the potential that some see for the sector.