People don't understand that buying property with a mortgage is just the same as buying stocks on margin. It's caused speculative bubbles and malinvestment. Until the malinvestment in those countries is entirely liquidated, you don't want to invest in real estate in them—Doug Casey
In this issue
Philippine Real Estate’s Diminishing Marginal Returns; 1Q Performance of Listed Firms; A Raging Global Real Estate Bubble! Will the Philippines Decouple?
I. Snowballing Malinvestments: The Real Estate Industry’s Diminishing Marginal Returns!
II. As Bank’s Real Estate’s Credit Portfolio hits Record, Non-Performing Loans Rocket
III. Liquidation Phase: Downtrend in Sectoral GDP, Faltering Liquidity and Falling Prices
IV. PSE’s Real Estate 1Q Revenues, Sales and Net Income Drops as Debt Surges
V. Theory over Statistics: Why the BSP will Continue to Inflate Asset Bubbles
VI. A Raging Global Real Estate Bubble! Will the Philippines Decouple?
Philippine Real Estate’s Diminishing Marginal Returns; 1Q Performance of Listed Firms; A Raging Global Real Estate Bubble! Will the Philippines Decouple?
I. Snowballing Malinvestments: The Real Estate Industry’s Diminishing Marginal Returns!
The worst is over! That’s the prevailing consensus of the forecasts of mainstream analysts of the real estate industry.
They see the industry supported by the reopening of commerce as a result of the mass vaccination rollout, the National Government’s ambitious infrastructure spending programs, resilient growth of OFW remittances, the shift to the digital economy (logistics and warehousing), and improved demand from BPOs among the other factors.
Unfortunately, despite the numerous data made available by authorities, there appears to be little assessment of the long-term conditions of the industry.
Figure 1
This analysis attempts to plug or fill the chasm from such narratives.
To begin with, according to the Investopedia.com, “The law of diminishing marginal returns is a theory in economics that predicts that after some optimal level of capacity is reached, adding an additional factor of production will actually result in smaller increases in output.
In contrast to the mainstream perspective, the law of diminishing marginal returns has been plaguing the real estate industry.
Since its pinnacle in Q3 2013, the sector’s share of the real GDP continues to tumble. Interestingly, its downdraft picked up speed in Q3 2019 or before the pandemic. (Figure 1, upmost pane) That is, despite the mainstream’s bullish puffery, increases in the sector’s expenditures should further compound the trend of its decreasing value-added contribution to the statistical economy. (more in the next section)
I’m no fan of the GDP, but the numbers provided by the authorities merely confirm our thesis.
And there’s more.
From the perspective of opportunity cost, resources and finances devoted to the sector, which generates sub-optimal output, contributes to misallocation and diversion of use to unproductive activities that result in the consumption of capital.
The misdirection of resource usage, spurred by the BSP’s low policy regime or easy money policy, is called malinvestments.
As Austrian Economist and Professor Peter G. Klein explained,
“Central to the “Austrian” understanding of business cycles is the idea that monetary expansion — in Wicksellian terms, money printing that pushes interest rates below their “natural” levels — leads to overinvestment in long-term, capital-intensive projects and long-lived, durable assets (and underinvestment in other types of projects, hence the more general term “malinvestment”).
Peter G. Klein, Easy Money and Asset Bubbles, Organization and Markets October 28, 2013
To compound the issue, the banking system’s loans to the sector continue to gain momentum even as its GDP declines. The share of the universal-commercial bank loans to the real estate supply-side sector reached a historic 20.04% in Q1 2021! (Figure 1, middle pane)
This necessity to keep the sector afloat with sustained credit infusion is why the BSP extended the sector’s loan limits in August 2020.
The real estate sector defied the loan conditions of the banking system during the pandemic. Bank loans to the industry (supply) and consumers (demand) remained positive in Q1 2021 but at a diminishing growth rate.
In Q1 2021, the banking system’s consumer real estate loans grew by 7.87%, while the industry’s loans increased by a puny 1.49%.
The banking system’s Total Loan Portfolio (TLP) shed 4.13% over the same period. Nevertheless, bank loan growth to the sector has been southbound since at least 2016.
Thus, the sector’s lending share was boosted by the growth rates, even as Total Banking Loans contracted.
To reinforce the thesis of diminishing returns. The slackening growth rate of performing loans relative to the uptrend in the growth rate of non-performing loans since 2016 corroborates further the declining viability of the sector. The pandemic only accelerated this dynamic. (Figure 1, lowest pane)
In this context, the prospects of lower economic viability and increasing financial leverage constitute a fatal mix that increases the risks of systemic insolvency.
II. As Bank’s Real Estate’s Credit Portfolio hits Record, Non-Performing Loans Rocket
Figure 2
The real estate industry breathes in the oxygen of credit.
In this case, without dealing with its financing mechanism, there can be no meaningful investigation or analysis of the industry.
The rising share of Consumer Loans (CL) started in 2014 but accelerated in 2018 as industrial loans underperformed. (Figure 2, upmost window)
Consumer loans as a share of the banking system’s Total Loan Portfolio (TLP) registered 19.18%, just slightly off the record high of 19.33% in 3Q 2020. Industry loans make up the rest.
As such, the % share of CL Non-Performing Loans (NPL) relative to the TLP rocketed to 1.87%, its highest level since at least 2009! (Figure 2 middle pane left)
The % share of CL NPL to the Total NPL slipped 44.79% from the recent record high of 49.92% last 4Q 2020.
In Q1 2021, consumer real estate (CRE) loans accounted for 42.6% of the total CL portfolio accounting for the highest share since 2Q 2015.
However, the outsprinting of credit card and motor vehicle loans from 2015 to 2019 sent the % share of CRE loans downhill. But the pandemic changed this equation. ! (Figure 2 middle pane right)
As credit card and motor vehicle loans plunged, the slowing positive growth rate of CRE loans sent the latter’s share to reclaim dominance. To stall the rate of credit card delinquencies, the BSP imposed an interest rate cap on credit cards. The BSP extended this subsidy this April, shrouding the deterioration of credit card conditions.
Nonetheless, CRE NPLs as a % share of TLP soared to a new record of .77% in Q1 2021. CRE NPLs as a % share of Total RE loans zoomed to 9.44%! (Figure 2, lowest pane)
Reported NPLs, as previously highlighted, comes in the light of the unequaled rescue measures implemented by the BSP, thus, have little relevance in comparison with the past.
And more. Banks and financial institutions may not be fully transparent of the actual conditions of loans. The relief measures of the BSP provide these institutions motive for it.
In any case, aside from surging vacancies across the different sectors like office spaces, malls, and residential, the swelling of NPLs should add to the supply issues.
Importantly, mounting credit impairments translate to collateral issues in the context of loan portfolios for the banking system.
III. Liquidation Phase: Downtrend in Sectoral GDP, Faltering Liquidity and Falling Prices
The mainstream, unfortunately, downplays the crucial role played by collaterals.
In any case, let us take it from the reflexivity theory as explained by the billionaire speculator George Soros:
Typically bubbles have an asymmetric shape. The boom is long and slow to start. It accelerates gradually until it flattens out again during the twilight period. The bust is short and steep because it involves the forced liquidation of unsound positions. Disillusionment turns into panic, reaching its climax in a financial crisis.
The simplest case of a purely financial bubble can be found in real estate. The trend that precipitates it is the availability of credit; the misconception that continues to recur in various forms is that the value of the collateral is independent of the availability of credit. As a matter of fact, the relationship is reflexive. When credit becomes cheaper, activity picks up and real estate values rise. There are fewer defaults, credit performance improves, and lending standards are relaxed. So at the height of the boom, the amount of credit outstanding is at its peak, and a reversal precipitates false liquidation, depressing real estate values.
George Soros 'We have just entered Act II of the drama', theage.com.au June 11; Businessinsider June 14 2010
There are many signs of the liquidation phase of the real estate cycle. Surging NPLs and credit delinquencies, diving prices, shrinking liquidity, contracting output, layoffs, and higher rates are among the many parameters.
First a reminder. To avoid mass liquidations, which would severely affect the banking sector and trigger a financial crisis, the BSP launched a historic rescue package that included over Php 2 trillion in liquidity infusion through its asset expansion, cut policy rate and bank reserves, provided operational and regulatory relief measures, adjusted select credit risk weightings, increased allowable eligible securities for rediscounting, mandated credit allocation to select sectors and more.
Next, the explanation of the tumbling share of the real estate GDP.
Despite the unprecedented Php 2.45 trillion asset expansion of the BSP, from February 2020 to March 2021, the 1Q real estate GDP remained contractionary in nominal (-10.2%) and real terms (-13.2%).
Its long-term GDP performance highlights the declining trend in the share of real estate GDP to the national GDP. Since culminating in 2013, the sector’s Nominal GDP and Real GDP have been in a cascade. The pandemic merely tipped its scale or sent its GDP into a waterfall. (Figure 3, topmost pane)
Yes, as history has shown, no trend goes in a straight line, and there will be interim bounces. But the long-term trend shall persist unless markets will be allowed to rectify the entrenched imbalances. In any event, since current conditions are unsustainable, that scenario is inevitable.
The previous overspending in the sector will transform into idled assets, earnings losses, and cash flow drought, again, signs of consumed capital.
And not limited to mounting infeasibility, falling prices from faltering liquidity signify as another symptom.
Because credit is the industry’s oxygen, banks are the primary source of liquidity.
Despite the rescue efforts by the BSP, which have only kicked the proverbial can down the road, wobbling prices of real estate prices extended through the 1Q 2021.
Figure 3
Based on data from the Bank for International Settlements, commercial and residential real estate prices in Makati sunk 17.5% in Q1 2021 for the second straight quarter. It shrunk by 10.96% in Q4 2020. (Figure 3, middle left pane)
Further, a double top has appeared in prices of Makati Apartments based on Global Property Guide. (Figure 3, lowest window)
Also, weighed by the 10% plunge of the NCR, real estate prices fell by 4.2% nationally in the 1Q 2021, based on the BSP's Real Estate Index. (Figure 3, middle right pane)
In the current circumstance, fading money supply benchmark M3 accompanied the sector’s price deflation signifying a reduction in liquidity or insufficient credit flows.
As the data indicates, lackluster demand has met overwhelming supply.
Survey results, conducted especially by special interest groups, may not proximate the actual conditions.
IV. PSE’s Real Estate 1Q Revenues, Sales and Net Income Drops as Debt Surges
Figure 4
Not only falling prices and contracting output but also submerging revenues of the industry, represented by listed firms, signify floundering demand, despite efforts by some to prop these up statistically.
Revenues of property firms of the PSEi, members of the old and new Property Index plummeted 11.5%, 11.51%, and 11.6%, respectively. The old index excludes 8890 [PSE: HOUSE] and Primex Corporation [PSE: PRMX]. (Figure 4, upmost table)
Real estate sales of the same sectors dropped 4.5%, 5.8%, and 5.9%, correspondingly.
With a weak topline, the same sectors suffered 23.6%, 18.9%, and 21.33% dive in income, accordingly.
But whether income growth is positive or negative, the same sectors registered increases in debt 1.41%, 3.3%, and 3.0%, respectively.
In nominal figures, while property firms of the PSEi 30 endured a net income drop of Php 4.814 billion, debt increased by Php 8.7 billion. Incredible.
Meanwhile, the aggregate revenues or sales dived 11.5% for the major listed retailers, potential indicators of the financial conditions of tenants of the commercial real estate sector. Jollibee's indicated revenues, in particular, are from domestic activities. (Figure 4 middle pane)
As it is, the property sector appears to be in an early phase of retrenchment and liquidations.
As applied to the stock markets, as of June 25th, property firms account for about 21.78% of the free-float market cap of the headline equity benchmark. (Figure 4, lowest window)
Meanwhile, holding firms, which comprise about 38.5% of the same benchmark, likewise have substantial exposure to the real estate industry. Because the property firms of this index are also subsidiaries, they duplicate the exposure of the biggest holding firms.
Nevertheless, in the hope of buoying the asset class or its collateral values, the excess liquidity of the banking system appears to be percolating into property stocks, seemingly designed to reinstate credit flows.
V. Theory over Statistics: Why the BSP will Continue to Inflate Asset Bubbles
The above facts serve as a slew of evidence why the BSP will likely continue to use its balance sheet and other relief measures to prevent asset/collateral values from falling into a deflationary spiral.
From the Businessworld back in December 2, 2020: THE property market could emerge as a risk to the banking sector if prices stall, while an increase in bad loans overall in 2021 is not likely to significantly threaten bank profits because of aggressive provisioning by many banks early on, Fitch Ratings said. “We expect the deterioration in reported asset-quality metrics to accelerate in 2021 as debt moratoria mandated by regulations expire in December 2020, though the impact on profitability is likely to be cushioned by the banks’ pre-emptive general provisioning in the preceding year,” Fitch said.
Of course, the BSP had to maintain its policy rate this week: primarily, it provides a subsidy to the banking system by forcing lower deposit expenses coming at the expense of the saving public.
Second, lowered rates help support collateral values through loan rollovers and credit expansion to the biggest clients of the banking system: the real estate sector.
Third, low rates allow financial institutions to go on debt-financed yield-chasing activities in the marketplace, again to bolster collateral values/asset prices.
Oddly, after all the unparalleled measures in place, the BSP tells the public it will expand the metrics used for monitoring risks.
From the Inquirer (June 3): The Philippine central bank is keeping a close watch on real estate prices as part of its efforts to protect the financial system preemptively against risks, which would set the stage for the regulator to augment current monitoring mechanism to improve its early warning system. At an online press briefing, Bangko Sentral ng Pilipinas (BSP) Governor Benjamin Diokno said that the regulator will add a Commercial Property Price Index “within the year” to give policy makers a clearer picture of the market currently provided by its quarterly Residential Real Estate Price Index. “Together, these two indicators may be used to monitor the developments in the Philippine property sector as a whole and their linkages with the other sectors in the economy,” he said. According to Diokno, the adoption by the BSP of the property price index has strengthened its market surveillance activities which are essential to the identification of risks and the formulation of policies. “Using [property price] data, the BSP is able to measure and monitor the banking sector’s exposure to the residential property sector, monitor developing price and credit trends, and develop timely and appropriate policies, together with other regulatory agencies, if needed, to stem the rise of systemic risk,” he said.
Responding to the concern by some of a real estate bubble, the BSP assimilated its peers by putting up a price index. They used it to deny the existence of bubbles in 2019 while implying otherwise in the FSRs. Then with the current real estate price deflation, they expand their statistical tools to (supposedly) enhance their anticipation of the risks of bubbles in the hope of assuaging the public.
But statistical data are there to support theory than the other way around.
As the great Austrian Economist Ludwig von Mises explained
Experience of economic history is always experience of complex phenomena. It can never convey knowledge of the kind the experimenter abstracts from a laboratory experiment. Statistics is a method for the presentation of historical facts concerning prices and other relevant data of human action. It is not economics and cannot produce economic theorems and theories. The statistics of prices is economic history.
Ludwig von Mises, 5. Logical Catallactics Versus Mathematical Catallactics Chapter 16 Human Action, Mises.org
History as embedded in statistics, in short, is not economics.
Instead, revealed or demonstrated preferences tell us that the unprecedented rescue efforts by the BSP are sufficient manifestations of the degree of difficulties confronting the banking-real estate sector.
Nonetheless, affordability is one of the implicit traits of bubble risks raised by a few quarters.
From the CNN (June 10): Manila has become the second worst city in Asia in terms of property affordability, recent research by a UK-based mortgage company revealed. Online Mortgage Advisor found that the Philippine capital is the least affordable city for buying property in Asia next to Mashdad in Iran.
From the Businessworld (June 23) MANILA is the 78th most expensive city for expatriates to live in according to Mercer’s 2021 Cost of Living Survey, as the Philippines’ capital city jumped two spots from the previous year’s ranking. Manila tied with Mumbai, India at 78th out of 209 cities in the Mercer survey that compares the costs of 200 items in each location, including housing, transportation, food, clothing, household goods, and entertainment.
See why the share of real estate GDP continues to tumble?
VI. A Raging Global Real Estate Bubble! Will the Philippines Decouple?
From global real estate consultancy Knight Frank: Globally, house prices are rising at their fastest rate since Q4 2006. Knight Frank’s Global House Price Index, a means of benchmarking average prices across 56 countries and territories, increased 7.3% in the year to March 2021.
From global real estate research and agency Global Property Guide (May 31): During the year to Q1 2021: -House price increases have accelerated to an amazing extent in many countries in Europe, Asia-Pacific, and the U.S. and Canada. The magnitude of this boom is utterly unprecedented. Low interest rates and monetary easing must be assumed to be the main cause. -Real house prices (i.e., prices adjusted for inflation) rose in 43 out of the 57 world’s housing markets which have so far published housing statistics. The more upbeat nominal figures, more familiar to the public, showed house price rises in 50 countries, and declines in only 7 countries.
From the Bloomberg [gated] (June 15): Real estate prices around the world are flashing the kind of bubble warnings that haven’t been seen since the run up to the 2008 financial crisis, according to Bloomberg Economics. New Zealand, Canada and Sweden rank as the world’s frothiest housing markets, based on the key indicators used in the Bloomberg Economics dashboard. The U.K. and the U.S. are also near the top of the risk rankings.
Figure 5
A global asset bubble is raging. Some have coined this the "everything bubble."
Aside from stocks and fixed income securities, real estate prices have been rocketing in most parts of the world. Yes, "rocketing"...accelerating growth rate!
In May, the stock market index of MSCI Global Real Estate has broken beyond the February 2020 highs (blue trend). But it has trailed the phenomenal run of the equity benchmark, the MSCI World Index (yellow-trend). (Figure 5, upmost left)
As stated by Knight Frank, prices of its Global Real Index have risen at the fastest rate since Q4 2006, the eve of before the US Centered Great Recession of 2007-2008. (Figure 5, upmost right)
Bloomberg’s global gauge of housing affordability has surpassed the record 2008 levels. (Figure 5, lowest left)
In no time in history has housing prices been so overpriced.
Global Property Guide says that 75% of the global real estate market increased based on inflation-adjusted prices.
In Germany, the spectacular parabolic rice in the German House Price index has chimed with the remarkable balance sheet expansion of the European Central Bank. (Figure 5, middle pane)
The massive surge in the collective balance sheets of the global central banks have fueled asset bubbles, as demonstrated by turbocharged real estate prices in Germany.
The data from Global Property Guide shows that the Philippines' RE prices lagged the world. On the surface, this should be good news. But the reason for this is not just because of income, jobs, wage, and earnings losses from the great socialist pandemic lockdown, but because banks have been in a tightwad mood from years of carefree lending.
Yet, the BSP continues to inflate the system intensively.
From our perspective, the pricking of this majestic bubble will envelop the world, including the Philippines.
Good luck to those who believe that the Philippines can decouple.
