To this day, there are precious few Southeast Asian tycoons whose wealth is not rooted in some form of state-sanctioned monopoly. (The exceptions are a couple of lesser Hong Kong billionaires, Patrick Wang of micromotor maker Johnson Electric and Michael Ying of clothing business Esprit, whose money was made in recent years in manufacturing in mainland China.) Soft-commodity monopolies for consumer items like sugar and flour produced early cash flows for Indonesia's Liem and Malaysia's Robert Kuok. Gaming licenses primed Stanley Ho in Macau and Lim Goh Tong, Ananda Krishnan and Vincent Tan in Malaysia, and lumber concessions made Mohamad (Bob) Hasan, Prajogo Pangestu and Eka Tjipta Widjaya in Indonesia. In Hong Kong and Singapore, real estate became an effective cartel because of the way British colonial regimes structured the land market—selling off "crown land" in large lots that created a barrier to entry for all but a few big players. In the 1990s land packages in Hong Kong were commanding prices of about US$1 billion. The city-states also restricted access to their banking markets, creating other huge rents for local players; the biggest of all went to the institution that is now known as HSBC—Joe Studwell
In this issue
Q2-1H 2023 Performance of the Philippine PSE Listed Property Firms Validated the Q2 4.3% GDP Slump
I. Q2 Real Estate Downturn Spreads from Office to Retail to Residential Condominiums
II. Leading Supply Indicator: Q2 Residential and Non-Residential Construction Permits Plunged!
III. Top 5 Property Firms: Q2-1H Total and Rental Revenues Growth Rates Stumbled!
IV. Top 5 Property Firms: Q2 Real Estate Sales Growth Contracted! Debt Outpaced Net Income Growth
V. Property Index: Increasing Industry Concentration; Escalating Fragility from Diminishing Top-Line Performance and Mounting Liquidity Strains
Q2-1H 2023 Performance of the Philippine PSE Listed Property Firms Validated the Q2 4.3% GDP Slump
Remember the Philippine Q2 4.3% GDP shock? This slowdown was also evident in the property industry, depicted by the financial performance of PSE-listed property firms in Q2 and 1H 2023.
I. Q2 Real Estate Downturn Spreads from Office to Retail to Residential Condominiums
How has the real estate industry been doing in 1H?
Let us open with a few excerpts from the news. (all bold mine)
On home affordability:
GMA News, June 28: Just how affordable are houses in Metro Manila compared with other countries in Asia? Data from the 2023 Urban Land Institute (ULI) Asia Pacific Home Attainability Index showed that Metro Manila's home affordability ratio is one of the highest or most expensive in the region after the cities in China, Vietnam, Hong Kong and Indonesia.
On the impact of elevated vacancy rates on banks:
Businessworld, August 14: RISKS to the commercial real estate sector in the country may also pose threats to the asset quality of the banking industry given its exposure to the property sector, according to S&P Global Ratings. “Given the banking sector’s sizable exposure at about 13% of total loans, any significant deterioration in the commercial real estate sector will affect the banks’ asset quality,” S&P Global Ratings Associate Director Nikita Anand said in an e-mail…According to Ms. Anand, the office vacancy rate in Metro Manila is still elevated due to the supply overhang and continued hybrid work arrangements. “This has not translated into asset quality issues so far as reflected by the low reported NPL (nonperforming loan) ratio of 2.1% for commercial real estate loans,” she said…Joey Roi H. Bondoc, research director at Colliers International Philippines, said the office vacancy rate in Metro Manila is projected to increase to 21.2% this year. As of the first half, the office vacancy rate is at 18.4%. “We’re projecting a 21.2% vacancy rate because there will be about 670,000 square meters of new office space to be completed in Metro Manila,” Mr. Bondoc said in a phone call interview. For the retail property sector, the vacancy rate may inch up to 15% this year, from 14% last year. “For the commercial real estate sector, that’s a big concern as this might stifle the growth of retail rents. We might see slower growth in rents for 2023,” Mr. Bondoc said. Vacancy rates continue to rise as many companies do not renew or pre-terminate their lease contracts. Some companies are also rightsizing their office space requirements as workers continue to opt for hybrid work arrangements.
On its transmission to the residential sphere:
Inquirer.net August 24: Residential tower vacancies in Metro Manila are set to rise in 2024 as property investors banking on the once-thriving demand from China-focused Philippine Offshore Gaming Operators (Pogo) find few takers amid an ongoing exodus. Real estate consultancy giant Colliers Philippines said residential towers in the Manila Bay area could see the largest surge in vacancies next year as new supply hits the market, overtaking areas such as Bonifacio Global City and Makati City…Bondoc said overall condominium vacancy rates in Metro Manila could tick higher next year from 17.2 during the second quarter of 2023. This would also weigh on residential lease rates and selling prices in the secondary market.
A synopsis of the news quotes:
1) Philippine property prices are relatively less affordable (more expensive) compared to some in the region.
2) Supply gluts and hybrid work arrangements have increased vacancy rates in the office and retail segments of the commercial property sector (CRE).
3) Elevated vacancy rates could affect the bank asset quality, which translates to higher risk for banks.
4) Supply overhang in the CRE has spread to residential condominiums.
Last May, we proposed that the problems experienced by the office segment will likely disperse and affect a larger spectrum of the industry.
The thing is, though office spaces are the concern here, all other segments of the property sector constitute part of such "integrated communities," which therefore extrapolates to interconnection.
By extension, it also means that the paradigm of "integrated community" is codependent not only on the vibrancy of the office properties but also residential, shopping malls, hotels, logistics and commercial hubs, and other related structures.
Indeed, the dilemma of the office segment, the weakest link of the commercial real estate sector (CRE), should spread to other areas (Prudent Investor, May 2023)
So, there you have it.
The slowing credit and liquidity flows diminish economic activities that should further increase pressures on the elevated vacancy rates. In turn, the worsening conditions should percolate into banks as increasing credit delinquency rates and an escalation of asset quality problems.
Figure 1
As evidence, Total Bank Real Estate (RE) supply-side loans slowed from 4.22% in Q1 to 3.8% in Q2. Meanwhile, RE "real" GDP also eased from 3.2% to 2.8% in Q2. (Figure 1, topmost chart)
In general, since credit is the lifeblood of the RE sector, its slowdown impacts the industry's activities while raising their risks.
The limitations on the RE consumer loans data, which has yet to be published, constrain our assessment.
II. Leading Supply Indicator: Q2 Residential and Non-Residential Construction Permits Plunged!
Let us move on to the other evidence.
This substantially slowing changeover has already been apparent in the Philippine Statistics Agency PSA's Q2 2023 construction permit data.
The massive supply glut has led to a sharp contraction (YoY) in the number (20%) and floor area (25.6%) of residential construction permits in Q2. Though the number of residential condos grew by 9.1% in Q1, floor area and value plunged by 67.4 and 67.1%, respectively. It was a broad-based decline for the residential permits. (Figure 1, middle window)
And though non-residential permits surged (10.1%) primarily due to the commercial (15.7%) segment, the floor area and their value also suffered a steep 15.2% and 18.7% shrinkage. (Figure 1, lowest graph)
That said, this data translates to an increase in the supply of smaller "commercial" units, which penny-pinching activities extrapolate to the furtherance of the slowdown.
The construction permits represent an indicator of the upcoming supply. How about demand?
Given this, the performance of the listed real estate firms in Q2 and 1H 2023 may provide a clue.
III. Top 5 Property Firms: Q2-1H Total and Rental Revenues Growth Rates Stumbled!
Below, we present the activities of the top 5 listed RE firms and the members of the Philippine Stock Exchange PSE's Real Estate Index.
The five largest real estate listed firms by assets (Q2 2023): (in the pecking order) SM Prime Holdings (Php 914 billion), Ayala Land (Php 796 billion), Megaworld (Php 423 billion), Vista Land (Php 335 billion), and Robinsons Land (Php 242 billion).
Figure 2
The oscillation of the changes in aggregate revenues tracked the contour of the (current or nominal) real estate GDP, which slowed steeply in Q2. (Figure 2, topmost chart)
But there was a stark difference in %: gross revenue growth of the top 5 tumbled from 22.2% in Q1 to 8.42% in Q2, whereas Nominal GDP slipped from 10.5% to 9.1% or in real GDP from 3.2% to 2.8%. It could mean an overstatement of the NGDP.
For one thing, the Q2 aggregate revenue of the top 5 signifies 30.9% of the NGDP, which translates to a high concentration of activities of these elite firms relative to the industry.
Rent and Real Estate sales comprise two major segments of their revenues.
The thing is, rent revenues frequently reflected the sales activities of the top retail chains, some of which are their tenants.
Rent revenues of the top 4 (excluding ALI) slowed from 43.02% YoY to 26.4% in Q2. As an aside, ALI bundles rent with its real estate revenues.
In the meantime, aggregate sales growth of the top 6 retailers (SM Retail, Robinsons Land, Puregold, Philippine Seven, SSI Group, and Metro Retail) also fumbled from 16.35% to a stunning 6.5%! (Figure 2, middle diagram)
And peaking household credit has coincided with the weakening rent revenue growth. Household credit growth steadied or was little change from 26.34 to 26.03%. (Figure 2, lowest graph)
Figure 3
To wit, a surge in household leverage to finance spending has boosted the revenue of retail chains and shopping mall owners. Simultaneously, the spending binge bolstered the core segment of the CPI. (Figure 3, topmost chart)
To put it more precisely, slowing retail sales growth, a manifestation of slowing credit growth has been transmitted to rent revenues and the GDP.
It signals diminishing returns from credit-financed demand. It also signified increases in imbalances through disproportionate supply expansion.
IV. Top 5 Property Firms: Q2 Real Estate Sales Growth Contracted! Debt Outpaced Net Income Growth
Let us move on to the other evidence.
Rent revenues have masked the crucial slowdown in real estate sales.
Since credit has financed most transactions, consumer credit growth has coincided with sales.
Real estate sales of the top 5 listed firms have been stagnating. It shrunk by 2.52% YoY in Q2. Consumer RE loans grew by 7.5% in Q1, suggesting a moderation in Q2. (Figure 3, middle pane)
And since ALI's topline represents a package of rent and sales, the decline must have been steeper.
In any case, SMPH posted an incredible 71.3% surge, ALI 22.75%, and MEG 8.03%, while RLC and VLL endured substantial markdowns of 83.2% and 10.8%, respectively.
Amidst a multi-year high of CORE CPI, income growth of the top 5 posted a robust 33.13% in Q2. The industry maintained its wide profit margins—by passing through to consumers through higher selling prices—their increased input and operating costs. (Figure 3, lowest chart)
Figure 4
Q2 2023 average profit margins reached 39.7%, next to the all-time high of 40.4% in Q4 2019. (Figure 4, topmost graph)
Of course, consumers funded their purchases with a surge in debt.
And it's not just consumers wallowing in debt. Published debt of the top 5 property firms hit a fresh all-time high (ATH) in Q2!
Though debt grew by only 5.4%, it comes off a high base. In pesos, net or marginal growth Q2 YoY soared by Php 48.394 billion against a net or marginal income growth of Php 7.2 billion. (Figure 4, middle window)
On that score, the elite firms borrowed Php 6.73 for every peso income generated!
As it is, interest expense also surged to near-record highs, given the increasing debt load and higher rates! (Figure 4, lowest diagram)
In a nutshell, the industry will continue to navigate the treacherous waters of a slowing economy, surging debt loads (or leverage), higher inflation rates, deteriorating savings, and higher interest rates.
That's why the BSP extended the interest rate cap on credit cards (subsidizing consumer credit card users at the expense of others)
And that's why the BSP floated another substantial cut in the banking system’s reserve requirements ratio (RRR).
V. Property Index: Increasing Industry Concentration; Escalating Fragility from Diminishing Top-Line Performance and Mounting Liquidity Strains
Figure/Table 5
Expanding the breadth to cover the members of the Property index doesn't change the story since the performance of the top 5 members dictates the overall.
In 1H'23, the top 5 accounted for a critical majority of the property index: 80.9% debt, 82.12% revenues, 83.6% real estate sales, and 79.16% cash. (Figure 5, upper table)
Over the same period, total revenues signified a 36.1% share of the real estate NGDP and 37.6% NGDP in Q2. (Figure 5, lowest table)
The point is that a few listed firms control a critical share of real estate activities nationwide.
As it stands, the property index excludes PSEi 30 holding firms with extensive exposure to real estate, like Aboitiz Equities, DMCI Holdings, GT Capital, and LT Group, through unlisted subsidiaries.
Adding them to the sales statistics would substantially increase the share of real estate activities of elite-owned or controlled firms relative to the GDP.
That is aside from the inventories that have been deliberately withheld from the marketplace to "reduce" supply, "inflate" values, and "expand" future profits.
Besides, the calculation of the net worth of the Forbes Philippine wealthiest, aside from stocks, includes real estate holdings and other assets.
The thing is, centralization or cartelization of an industry doesn't depend alone on partisan political policies or the arbitrariness of a regulatory regime.
Monetary policies play a critical role in corralling property inventories and businesses for the benefit of the elites.
Total banks and universal commercial (UC) banks have almost monopolized the nation's financial resources, cornering about 82.4% and 77.4% as of May 2023.
That is to say, UCs and banks have a set of preferred clients—who are endowed with special privileges that aren't available to the public.
Most banks have sibling companies engaged in the property business.
As privileged borrowers, elite property firms can access credit at substantially lower rates, allowing them to outbid other competitors for properties or businesses, which leads to the concentration of activities.
In effect, the transition towards centralization of banks has also led to increased concentration in real estate activities. It's the trickle-down policies at work.
Circling back to the 1H-Q2 Performance of the Financial Index, the data also suggested that even as the pressures on the corporate top line became evident, Q2 contributed the most in gross and marginal changes in 1H net income with 53.02% and 57.52% share.
Net income was supposed to have grown 29.5% and 32.8% in 1H and Q2, but cash plunged by 17.9% while debt increased by 5.8%.
In pesos, marginal net income growth was Php 15.54 billion and Php 8.94 billion in 1H and Q2, but cash contracted by Php 29.3 billion, and debt surged by Php 64 billion.
Some members of the property index are Real Estate Investment Trusts REITs, which do not sell properties.
Notwithstanding, real estate sales accounted for 59.7% of revenues of non-REIT members in 1H and 60.25% in Q2 2023.
In essence: Despite published net income, the industry faced substantial liquidity pressures (cash contraction) and, therefore, resorted to significant borrowings to plug these deficits.
The conformity of news anecdotes with macro statistics, plus the Q2 and H1 financial performance of listed property firms, confirms the ongoing downturn, exposing the sector's increasing fragility and mounting risks (including banks).
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References
Prudent Investor, Philippine Real Estate: Mainstream Expert Worried Over Increasing Demand-Supply Gap; Q1 2023 Data of Top 5 Listed RE Firms and the Property Index, May 29, 2023: Substack, Blogger
