Cracks in the Philippine Property Bubble?

The race to build real estate projects funded by debt by property developers and by the government has been rapidly inflating domestic property prices.

I was surprised to have read an article[1] citing a Jones Lang LaSalle (JLL) research as saying with unabashed confidence that despite soaring prices and massive supply growth there is no glut in the property sector (bold mine)

A sharp increase in new supply began in 2005. Since then, supply growth has averaged more than 30% annually. The total stock of condominiums jumped from 7,000 at the beginning of the millennium, to around 90,000 units by end of 2011, according to JLL. But Jll sees no glut, and CBRE Philippines’ executive director for global research and consultancy, Victor Asuncion, shares the same viewpoint….

Vacancy rates in Makati rose to 11.7% in Q1 2012 from 9.4% a year earlier, according to Colliers. The rise is attributable to new condominiums adjacent to, but not in, Makati - and in regions near Metro Manila.

This is a prime example of Warren Buffett’s advice of “never ask a barber if you need a haircut”. People will continue to talk up their industry regardless of the risks and of reality.

Common sense tells us that if economic growth stands at 7%, and supply side growth is at 30% annually for the last 8 years, unless the law of economics grind to a halt, eventually there will be a glut.

But the statistical economic growth which the article relies on as demand for burgeoning supplies has exactly been driven by the supply side growth of the property sector.

The article says that a remittance based demand is likely to slow due to factors which they refer to World Bank as -Stricter Implementation of the migrant workers’ bill of rights; -Political uncertainties in host countries; and -The slowdown in the advanced economies. The Pollyannaish article also pins on the growth of BPO industry as potential source of demand.

Yet the rise in vacancy rates in Makati by 11.7% from 9.4% while seemingly statistically small represents a 24.45% increase! And this could be the periphery to the core process.

I have pointed out in the past that the Asian crisis was partly triggered when Thailand’s vacancy rates soared to 15%[2].

The article only confirms my observation of a debt driven property bubble.

Total real estate loans country-wide soared by 42% to PHP546.51 billion (US$12.47 billion) in 2012 from the previous year, based on figures from the Bangko Sentral ng Pilipinas (BSP), the country’s central bank. Despite the spectacular growth, the size of the mortgage market remains small at about 5.5% of GDP in 2012.

Of course, the mortgage market is small and will likely remain small because of the limited penetration level by the population on the formal banking industry. This isn’t Singapore or Hong Kong. We should see a bigger enrolment of the population on the banking industry first before we can expect the mortgage markets to expand. And the banking industry would have to downscale regulations for more people to enrol. 

The property market reflects on the conditions of the stock market. 

Figure 8 World Bank Market Cap as % of GDP

The boom in local stocks which in 2012 market capitalization of listed companies according to World Bank accounts for 105.6% of the GDP[3] has only added 22% for a total of 525,850 accounts for the entire PSE brokerages from 2007[4]. This means that booming stocks benefits less than 525,850 accounts (individuals or corporations) or particularly the 83% of market capitalization controlled by a few families whom are now using aggressive leveraging.

The article also notes that “Most houses are sold for cash or pre-sold. Property buyers also face high transaction costs, corruption and red tape, fake land titles and substandard building practices.” The cash transactions are manifestations of clout of the informal economy and the dearth of access to the formal banking sector. And part of the preselling has been financed by developers themselves which the World Bank calls as the domestic shadow banking industry[5].

Finally here is the kicker, from the same article “Recovery from the subsequent crash has been slow. Nominal prices are now back above 1997 levels, but prices are still 46% below pre-Asian crisis peak levels in real terms (Q1 2012) – an astonishing reminder of how much the crash cost.”

Real terms (based on government statistics) don’t seem as an adequate or accurate representation property values.

My neighbourhood store raised the prices of my favorite merienda lumpia by 20% about 2 weeks ago. My daughter’s favorite pie Banoffee recently jumped by 10%. My favorite vendor who maintains his fishball price at 50 cents has shown a considerable shrinkage in the size of his products. I asked why this is so, he says that his supplier can’t raise prices so they deflate the size of their products. Real time economics from the man on the street. Even government’s lotto prices has recently been doubled which accounts for 3.93% lotto inflation. My neighbourhood rental prices have increased by about 10%.

The statistical world is far from the real world. It seems ivory tower economists don’t ever spend at all to know of this reality.

And by the way, a domestic central banker admits that CPI prices don’t accurately reflect on real inflation. At a Bank of International Settlements paper BSP Deputy Governor Diwa C Guinigundo writes[6] (bold mine)

Excluding asset price components from headline inflation also has little effect. Currently, the CPI includes only rent and minor repairs. The rent component of the CPI is, however, not reflective of the market price because of rent control legislation. The absence of a real estate price index (REPI) reflects valuation problems, owing largely to the institutional gaps in property valuation and taxation. While the price deflator derived from the gross value added from ownership of dwellings and real estate could represent real property price, it is also subject to frequent revisions, making it difficult to forecast inflation.

There you have it. The cat is out of the bag. Philippine CPI inflation is NOT a reliable indicator of inflation.

Importantly, real estate nominal prices have reached the 1997 highs.

And lastly I often hear officials say how much a backlog in demand for property in the low end market as a retort against suggestions of bubbles. They have suggested that the shortage of the housing industry is as much as 7 million units[7].

The problem with this concept is that low cost and socialized housing is not a market based demand, but rather a political demand for housing.

The basic assumption is that lack of housing is mainly a pecuniary factor caused by inequality or the lack of social justice. So the government undertakes programs to expand homeownership via socialized or subsidized housing.

So for instance when the BSP claims that 68% of households owns or co-owns their houses[8], this leaves 32% of households who don’t own their homes. This includes me. 

So from the government perspective this represents “demand”. Since there are 20.2 million household according to Bureau of Census estimates as of 2010[9], 32% equals 6.4 million!

But homeownership has not just been a function of income. It is also a choice. I personally know of a family who rents their residence at a posh exclusive village in Makati for years even when they can afford to buy 10 of them.

So the reality is that when vested interest groups ask the government to undertake mass housing projects to fill in an imagined demand gap for a cosmetic goal of social justice, the real issue is the transfer of resources from taxpayers to politically connected business firms, bureaucrats and to some welfare beneficiaries.

My guess is that the ongoing leveraging by players in the property sector whom has access to the banking system may be acquiring properties from the 68% of households and selling these projects to the same high end sector whom have been speculating both in stocks and in properties

Figure 9 US Homeownership rates

At the end of the day political demand via interventions to attain homeownership goals by blowing bubbles usually end up with the opposite effect. This can be seen in Figure 9[10]

The US experience should be a valuable example where homeownership rate has plunged to almost the 1995 levels even as homeownership programs spanned from different administrations[11].

Property bubbles will hurt both productive sectors and the consumers. Property bubbles increases input costs which reduces profits thereby rendering losses to marginal players but simultaneously rewarding the big players, thus property bubbles discourage small and medium scale entrepreneurship. Property bubbles can be seen as an insidious form of protectionism in favor of the politically privileged elites.

Property bubbles also reduces the disposable income of marginal fixed income earners who will have to pay more for rent and likewise reduces the affordability of housing for the general populace.

Outside the ethics of the property bubbles, the mania as shown by chronic overconfidence by industry participants, nominal prices of real estate at 1997 highs and signs of rising vacancy rates could be seen as a potential red flag especially if the bond vigilantes will reassert their presence.

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[1] Global Property Guide House price rises accelerating in the Philippines September 11, 2013

[2] see Phisix’s Mania: We’re Still Dancing March 11, 2013

[3] World Bank Market capitalization of listed companies (% of GDP)

[4] See Phisix: Will the Fed’s Spiking of the Punchbowl Party Be Sustainable? September 23, 2013

[5] See The Flaws of BSP’s Real Estate Monitoring and Banking Stress Tests May 20, 2013

[6] Diwa C Guinigundo Measurement of inflation and the Philippine monetary policy framework Bank of International Settlements

[7] Business Mirror Developers see housing woes worsening September 28, 2013

[8] Bangko Sentral ng Pilipinas 2012 Annual Report

[9] Bureau of Census Household Population of the Philippines Reaches 92.1 Million

[10] The Atlantic Cities The Steady Decline of Homeownership for Everyone, Everywhere July 31 2013

[11] See Will Record Rental Prices lead to Higher US Consumer Inflation? A Redux July 31, 2013

Will Record Rental Prices lead to Higher US Consumer Inflation? A Redux

Soaring property prices in the US has been prompting for a decline in homeownership.

From Bloomberg:

The U.S. homeownership rate, which soared to a record high 69.2 percent in 2004, is back where it was two decades ago, before the housing bubble inflated, busted and ripped more than 7 million Americans from their homes.

This serves evidence of the unintended consequences from noble-sounding social redistributionist policies of promoting homeownership through debt and inflationism.

This homeownership program has spanned the Clinton administration (June 5, 1995)  “Today, all across the country, I say to millions of young working couples who are just starting out: By the time your children are ready to start the first grade, we want you to be able to own your own home”…

…and the Bush Administration’s Ownership society (October 15, 2002) “working together as a nation to encourage folks to own their own home”

So the push for more homes via redistribution has led to bubbles that eventually defeats the original intent; Americans have now LESS homes. 

Differently said the housing bust has been greater than the boom.

The failed policy of promoting homeownership has began to put pressure on prices of rental properties.

On the demand side, from the same Bloomberg article: (bold mine)

The homeownership rate in the second quarter was unchanged from the prior three month period, according to Census Bureau data released today. It will hit bottom at about 64 percent in the next year as families leave the foreclosure pipeline and enter rental homes, according to a May analysis by London-based Capital Economics Inc. It’s currently the lowest in almost 18 years after averaging about 64 percent for 30 years through 1995.

The result of the switch to rental properties: soaring rental prices

From the Zero Hedge: (bold original, all chart excluding US Treasury yields theirs)

A record lot in fact: the median asking rent for US vacant housing units just hit an all time high of $735 per month.

The price rental increases has been nationwide. But the rate of increases differs by region where the Northeast has posted the biggest increase

Though there are more homeowners than renters, if the Fed fueled property boom persists and if income growth continues to stagnate (as shown by the above chart) then the shift to rentals could deepen, further undermining the homeownership levels

But what seems more important for now is the potential effect of higher rental prices to US CPI and to the financial markets.

If rental prices continue to soar, then given that housing rents comprises the biggest weighing in the CPI calculation, then record rental prices will mean higher CPI as I raised before (chart from dshort.com). 

Rising inflation expectations will thereby add further pressures on the elevated yields of US treasuries

While 5 year yields are off the highs, 10 and 30 year yields are knocking at new highs.

At the end of the day property boom will be threatened by the supply side response to prices…

From Wall Street Journal: (bold mine)

The speed with which prices have risen over the past year has taken many economists by surprise. Gains have been fueled by record-low mortgage rates, a slowly improving economy that has released pent-up demand and strong appetites from investors converting homes into rentals.

…and from higher interest rates or combination of both.

Again clearly policy induced boom bust cycles at work

2008 US Mortgage Crisis: The US Federal Reserve and Crony Capitalism as Principal Causes

Stanford University’s John B. Taylor reviewed Gretchen Morgenson and Joshua Rosner’s newest book, Reckless Endangerment: How Outsized Ambition, Greed, and Corruption Led to Economic Armageddon.

He finds that the Ms. Morgenson and Mr. Rosner placed the blame mostly on a complex crony based system between the financial industry and US Federal Reserve.

Mr. Taylor writes, (hat tip David Boaz) [bold emphasis mine]

The book focuses on two agencies of government, Fannie Mae and the Federal Reserve. The mutual support system is better explained and documented in the case of Fannie, the government-sponsored enterprise that supported the home mortgage market by buying mortgages and packaging them into marketable securities which it then guaranteed and sold to investors. The federal government supported Fannie Mae — and the other large government-sponsored enterprise, Freddie Mac — by implicitly backing up those guarantees and by providing favorable regulatory treatment and protection from competition. These benefits enabled Fannie to rake in excess profits — $2 billion in excess, according to a 1995 study by the Congressional Budget Office.

Fannie Mae was established as a government agency but became a private, shareholder owned company with a charter from Congress requiring the company to support the housing finance system. During the culmination of the crisis in 2008 Fannie Mae along with another Government Sponsored Enterprise (GSE) Freddie Mac was nationalized.

The point is that politically motivated enterprises operate distinctly from the incentives of free market forces. Such entities are wards of the state.

Yet none of this is new to followers of the Austrian school.

Murray N. Rothbard narrated on a parallel unholy relationship between the US Federal Reserve and the commercial banks [bold emphasis mine]

It should now be crystal clear what the attitude of commercial banks is and almost always will be toward the Central Bank in their country. The Central Bank is their support, their staff and shield against the winds of competition and of people trying to obtain money which they believe to be their own property waiting in the banks' vaults. The Central Bank crucially bolsters the confidence of the gulled public in the banks and deters runs upon them. The Central Bank is the banks' lender of last resort, and the cartelizer that enables all the banks to expand together so that one set of banks doesn't lose reserves to another and is forced to contract sharply or go under. The Central Bank is almost critically necessary to the prosperity of the commercial banks, to their professional career as manufacturers of new money through issuing illusory warehouse receipts to standard cash.

So whether it is the politically backed GSEs or the commercial banks, the US Federal Reserve implicitly treats them as natural political constituents.

Mr. Taylor adds,

The book then gives examples where Fannie’s executives — Jim Johnson, CEO from 1991 to 1998, is singled out more than anyone else — used the excess profits to support government officials in a variety of ways with plenty left over for large bonuses: They got jobs for friends and relatives of elected officials, including Rep. Barney Frank, who is tagged as “a perpetual protector of Fannie,” and they set up partnership offices around the country which provided more jobs. They financed publications in which writers argued that Fannie’s role in promoting homeownership justified federal support. They commissioned work by famous economists, such as Nobel Prize-winner Joseph Stiglitz, which argued that Fannie was not a serious risk to the taxpayer, countering “critics who argued that both Fannie and Freddie posed significant risks to the taxpayer.” They made campaign contributions and charitable donations to co-opt groups like the community action organization ACORN, which “had been agitating for tighter regulations on Fannie Mae.” They persuaded executive branch officials — such as then Deputy Treasury Secretary Larry Summers — to ask their staffs to rewrite reports critical of Fannie. In the meantime, Countrywide, the mortgage firm led by Angelo Mozilo, partnered with Fannie in originating many of the mortgages Fannie packaged (26 percent in 2004) and gave “sweetheart” loans to politicians with power to affect Fannie, such as Sen. Chris Dodd of Connecticut. The authors write that “Countrywide and Fannie Mae were inextricably bound.”

The above only shows that political distribution, whether it is in the Philippines or in the US, are apportioned not by merits but by political affiliations. And on the same plane, the gaming of the system by vested interest groups.

Again from Mr. Taylor,

The Fed takes a beating throughout the book. Early on the authors take on the Boston Fed, and in particular its research director Alicia Munnell, for using a study documenting racial discrimination in mortgage lending to justify the relaxation of credit standards, even though the study’s findings were found to be flawed by other researchers. And they criticize the very low interest rate set by the Fed when Alan Greenspan was chairman and Ben Bernanke was a Fed governor, saying it “contributed mightily to the mortgage lending craze,” adding that “with the Fed on a rate-cutting rampage, demand for adjustable-rate mortgages with relatively low initial interest costs had become incendiary.”

Well aside from low interest rates and the administrative policies to boost homeownership, there had been many other factors that has likewise contributed to the bubble, such as tax policies which encouraged exposure on debt rather than equity, agency problems and moral hazard (implicit backing from the Fed or the Greenspan Put), regulatory arbitrage which resulted to the creation of the (off balance sheet) shadow banking system, regulatory capture which played a substantial part of the crony relationships, the conflict of interest on credit rating agencies which had skewed incentives in favor debt issuers (investment banks) and many more.

Inflationism compounded by various forms of interventions represents as the anatomy of a bubble.

US Homeownership Shows The Bust Has Been Greater Than The Boom

Boom bust cycles are a net negative to a society.

The Wall Street Journal Blog narrates on the state of US Homeownership. (bold emphasis mine)

The release also showed that the housing bust has undone all of the gains in ownership rates that were much ballyhooed in the early and mid-2000s. The nation’s home ownership rate, at 66.4% in the first quarter, was down from 66.5% in the last three months of 2010 — the lowest level since 1998.

US homeownership fell more than the levels when the policy induced boom had been accelerated (meant to combat the dotcom bust during the advent of the new millennium). Thus, the damage incurred from the ensuing bust has been far greater than 'illusory' benefits of the boom.

As for China phobes: China played an insignificant role in the US housing bubble cycle engineered by the US government.

All these show that governments' penchant for blowing serial bubbles signify a path to a lower standard of living (poverty). As the great Murray N. Rothbard wrote,

“inflation reduces saving and investment, thus lowering society’s standard of living. It may even cause large-scale capital consumption”