A Rejoinder on Cuervo’s (non) response on my Philippine Property Bubble article

My article expounding on the possibility of an inflection point on the Philippine real industry, particularly Cracks in the Philippine Property Bubbles has elicited an industry response. 

I would like to thank Cuerve Property Advisors for citing my article as example of the property boom contrarians.

However, the Cuervo article seems to have sidestepped on the issues or the risks that I have raised. They mostly regurgitated on the 'positive' angles of the article I earlier questioned.  

(hat tip to my libertarian colleague Lemuel Goltiao)

Cuervo did not answer the following:

1. Has there has been an existing imbalance between demand and supply in the property sector?

The supply side which I questioned reported an average of 30% growth annualized for condominiums since 2005.

But how about demand?

A. Domestic Demand

In the second quarter, Philippine statistical economic growth was reported at 7.5% (constant prices).

Household demand or the HIFE was at 6.6% constant prices, where housing (along with water, electricity and etc) expenditures grew by 5.9%, according to the National Statistical Coordination Board.

For the sake of Occam Razor’s parsimony of logic rule, 30% (supply) minus 7.5% (demand) translates to 22.5% surplus. Yet not all consumer demand is about real estate as the table above shows.

B. BPO. The BPO industry grew by 18% in 2012 (but has averaged 46% since 2006 mostly due to what I see as the low base effect changes or from Wikipedia.org, the “tendency of a small absolute change from a low initial amount to be translated into a large percentage change”).

The Industry targets a near doubling of revenues at $25 billion in 2016 from $13 billion in 2012 or an average growth of 48% or cagr of 17.76%. There are only about 800,000 (777,000) people employed in the industry

However there are impediments to such aggressive growth target.

There haven’t been enough qualified employees, the Cebu BPO industry Blog notes that “According to the Business Processing Association of the Philippines (BPAP), out of every 100 applicants to call centers in Cebu and other cities, 95 of them are turned down. The companies just can’t find the right people for the number of jobs offered.”

Further there has been growing obstacles on labor regulation, notes China Daily Asia,

There were also concerns related to investment incentives and the legal and regulatory framework.

For instance, some foreign investors are surprised that employees cannot simply be let go, and that termination of employment needs to follow a particular procedure, otherwise the dismissal could be considered unlawful,” the law firm wrote. “Other new companies offer significant compensation packages at the very start of operations, not realizing that they may not be able to scale these back later on because of the local legal regime’s principle of non-diminution of benefits.

While I think BPOs will continue to grow strongly my impression is that the pace of growth will decelerate.

So if I simplistically refer to 2012 growth at 18%, real estate demand from BPO will not be enough. To the contrary BPO demand will translate to also a deficit of 12% (30%-18%). 

And even if we use the 46% benchmark, considering that the BPO is a small (but rapidly growing) industry yet, the 16% surplus will unlikely cover the deficits from the rest.

Yet benefits from the growth in the BPO industry won’t be all about real estate spending.

C. Remittance. Remittances reportedly grew at 7.4% in August. 

The World Bank in my earlier article notes remittance trend may slow due to “Stricter Implementation of the migrant workers’ bill of rights; -Political uncertainties in host countries; and -The slowdown in the advanced economies” which the Cuervo article seem to have overlooked.

Remittance growth trends have been on a decline since 2010 as shown by the World Bank Chart.

So again in simplistic deduction, demand from remittances represented by the 7.4% growth will also translate to a deficit (22.6%). Again not all of remittances will be directed to real estate.

The focus on remittances as main drivers of real estate (17-18% of total demand as assessed by a top property firm) seems misplaced. I have dealt with this here. Whatever happened to the 82-83%?

D. Foreign Demand. The global economy grew by 3% in 2012. IMF expects growth to further slip this year to 2.9% and 3.16% for 2014. 

The problem is the global economy has been materially slowing as shown above.

In addition, foreign demand for properties, whether for investment or for use, are subject to competition within the region.

Foreign demand is also subject to price and yield changes or the law of economics

And one should notice that BPO, remittances and foreign demand for local properties are sensitive to changes in the conditions of the global economy. Notes the World Bank from their (p.39) PHILIPPINE ECONOMIC UPDATE May 2013

However, the sources of growth can also become the sources of risk. A real estate sector driven by OFW sales and BPO leasing is vulnerable to shocks in the global economy. The low interest rate regime is also a source of risk. As lenders and developers compete for higher yields, lending requirements may be relaxed beyond prudent levels.

(bold mine) 

So it would be misguided to look at domestic developments in exclusion of external developments. The domestic economy has been materially entwined with the global economy. So even domestic demand is likewise sensitive to exogenous forces.

E. Informal Economy. Cuervo didn’t even tap the informal economy which the ILO estimates that between 40-80% of Philippine employment. [As a side note, the reason for the wide estimates is that the informal sectors are invisible to government statistical data] 

However, the Philippine Department of Labor and Employment estimates 41.1% of the Philippine labor force as informal, as of 2011

While the informal sector may not be buyers of high end projects, they are potential buyers of the middle to low cost housing. The informal economy also includes the 30-40% informal channel for remittance flows.

But these sectors are highly vulnerable to price inflation (whether food, energy or rents). Rent is a key component of poor and non-poor household spending as of 2003.

2. The company didn’t explain of the possible risks from potential oversupply and the risks of overleveraging of the industry. They seem to only assume that like stocks, property prices are headed only in one direction; up up and away.

3. They didn’t address how higher property prices will affect consumer affordability, disposable income and consequently demand.

4. The company also failed to explain how rising property prices will affect competitiveness, productivity and profitability of the general industries (including BPOs) when input costs led by rents go up.

At the end of the day the Cuervo analyst delivers the most important gist of their defense…which the late investing guru Sir John Templeton calls as the “four deadliest words in investing”:

As an experienced Appraiser, Real Estate Broker and Consultant, my opinion is now different.

This time is different.