Hazlitt says this: “Excessively low interest rates are inflationary because they mean that bonds, stocks, real estate and unincorporated businesses are capitalized at excessively high rates, and will fall in value even though the annual income they pay remains the same, if interest rates rise.” James Grant
Philippine Real Estate: Mainstream Expert Worried Over Increasing Demand-Supply Gap; Q1 2023 Data of Top 5 Listed RE Firms and the Property Index
Surprisingly, a previously bullish real estate institution exuded concern over the industry's growing demand-supply gap. Data from the top 5 property developers and the property index validates this unease.
Mainstream Real Estate Experts Worry About the "Build and They Will Come" Model
Philstar, May 18: Vacancies in offices in Metro Manila improved in the first quarter, but Colliers Philippines projected this would worsen by the end of 2023 as take-up remains anemic. Data provided by the professional services and investment management firm showed that office vacancies in the National Capital Region could likely hit 21% this year, higher compared to their previous outlook of 20.2%. Colliers attributed their projection to two key factors: slower take-up and completion of new office spaces in the country’s economic center. (bold added)
This outlook represents a remarkable turnabout from their earlier sanguine forecasts (here, here, and here).
They cite two fundamental issues for their flipflop, which we have always discussed: overinvestments in corporate offices (malinvestments) or extended supply in the face of slower demand.
They note that remote/hybrid work has partly contributed to these imbalances, although this met resistance from authorities.
As we noted here in early May,
Finally, protecting the real estate and banking industry underlies the principle behind the vehement opposition to hybrid, telecommuting, or remote work. A drastic change in consumer preferences on work locations will cause substantial dislocations into the "sunk costs" structured on traditional models of real estate operations. Vested interest groups will use politics to protect their turfs. (Prudent Investor, 2023)
There has been little realization that the industry has invested primarily in the foundation of the so-called "integrated community structure," anchored on urbanization and its extension of "satellite communities."
Espousing the contortion of Say's Law, "supply creates its own demand," through "build and they will come," the race to build became the industry’s bedrock.
Yet, the dynamic preference of consumers became one of the challenges of this model.
And so, influenced by digitalization and pandemic policies, the transformation to hybrid/remote work has rendered a massive "sunk cost" or capital decumulation—signified by oversupply.
Of course, the predicament of the expert assumes a perspective based on the present rates of GDP.
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.
Aside from the misallocation of capital, financing these imbalances through debt signifies a double whammy or the acceleration of capital consumption.
The point having been made, these clusters of entrepreneurial errors are products of the distortion of money via the BSP's easy money regime.
We shall examine this thesis from the prism of the GDP and banking system, the financial performance and the top 5 property developers, and the PSE's property index.
Malinvestments: Real Estate’s Slowing Share of GDP, Rising Share of Bank Credit
To begin with, the sector posted a current and real GDP of 11.3% and 3.8% in Q1 2023, which was one of the growth laggards. And it was not an anomaly but a trend.
Figure 1
Nonetheless, the real GDP rate of its subsector ownership and dwellings (ownership and rental services), which clocked in at 2.1%, pulled down the sector's value-added contribution.
Meanwhile, its other subcategory, real estate (sales & purchases, lease, appraisals, escrow, and other ancillary services), registered a 'real' GDP of 5.8%. (Figure 1, upper chart)
A better measure of the sector's contribution to the GDP is the delta of its share.
Despite its popularity, not only has its GDP rate been underperforming, but most importantly, its share contribution has also been on a downtrend since 2013. (Figure 1, lower window)
And because of its popularity and access to easy money, participants, including mom-and-pop realtors/developers, have joined the frenzy.
This decline in economic value signals the law of diminishing returns plaguing the sector.
Figure 2
In the meantime, the banking loans to the RE sector have slowed in the first three months of 2023.
Though it grew by 4.2% in March, its peso loan book was second to the highest at Php 2.18 trillion, a .4% decrease from December's all-time high of Php 2.188 trillion. (Again, this covers the supply side only) (Figure 2, upper pane)
And even though its share of the total (universal and commercial) bank loan portfolio dropped from its March 2022 zenith of 21.4% to a low of 19.6% in November, it rebounded to 20.3% in March 2023.
The thing is, the banking sector's largest client in credit transactions is the property sector.
For want of doubt, though the economic value added of the sector has been languishing, it continues to absorb the largest credit issuance by the banking system. (Figure 2, lowest chart)
That is to say, to keep the sector from falling further into entropy, banks have lubricated the sector's liquidity with sustained credit expansion. In a word, malinvestments.
Aside from revealing the structural infirmities and mounting risks, the GDP and the bank credit data also validate the mismatches from the observation cited in the above article.
In Q1 2023, Top 5 Real Estate Firms and the Property Index Affirmed the Imbalances
So, how did the top 5 property developers fare in Q1 2023?
The top 5 listed real estate firms are Ayala Land [PSE: ALI], SM Prime [PSE: SMPH], Megaworld [PSE: MEG], Robinsons Land [PSE: RLC], and Vista Land [PSE: VLL].
Have there been emerging signs of tensions to confirm such apprehensions?
Figure 3
While the current real estate GDP grew by 11.3% in Q1, materially slower than the 14.1% in Q4 2022, aggregate revenues of the top 5 developers increased by 22.15%, slightly higher than the 21.14% in the last quarter of 2022. (Figure 3, topmost window)
In pesos, Q1 2023 current RE GDP of Php 331.05 billion nearly matched the record in Q3 2019 of Php 332.9 billion.
In perspective, the aggregate revenues of the top 5 firms accounted for about 28% of the nominal/current real estate GDP.
The thing is, it was rent that pulled up the gross revenues. Rent revenues from shopping malls, corporate and residential centers, and others delivered the goodies.
And as previously noted, rent revenues have resonated with the growth in household credit both in % and peso levels. But since household credit growth appears to be plateauing/topping, so have rents. (Figure 3, middle diagram)
Meanwhile, the underperformance of real estate sales has weighed on gross revenues.
Slowing consumer housing loans (data still Q4 2022) appears to have decelerated real estate sales, which grew by 9.74%, down from 10.7% in Q4. (Figure 3, lowest chart)
But, the viewpoint of concern by the expert sees the current demand trajectory forward, but with supply growing faster.
It stands to reason that should bank credit slow substantially, a downturn in demand would escalate the imbalances expressed through a supply glut or increase vacancies.
For good measure, the revenue slack has also manifested in net income growth and levels.
Figure 4
Though Q1 posted an enormous jump in percentage, net income remained 22.5% below the highest feat attained in Q4 2019—which lagged the Core CPI.
And despite the underperforming topline, improving margins (since 2020), which echoed the Core CPI in 2022, secured their Q1 2023 net income.
More to the crux, because the industry depends on leverage for its business operations, its fundamental model flourished from the reign of the BSP's easy money. It needs cheap credit to survive.
Figure/Table 5
The property index—categorized by debt, revenue, and income—exhibited the same symptoms.
The index constitutes 17 members, including REITs. These are Ayala Land, AyalaLand Logistics, AREIT, Cebu Landmasters, Century Properties, Double Dragon, DDMP REIT, DM Wenceslao, Filinvest REIT, Filinvest Land, Megaworld, MREIT, Primex Corporation, RL Commercial REIT, Robinsons Land, SM Prime, and Vista Land.
In Q1 2023, Net Debt increased by Php 49.9 billion YoY Q1 2023, compared to the Net Revenue gain of Php 19.5 billion, net RE sales expansion of Php 6.7 billion, and Net (net) Income growth of Php 6.17 billion. Or the increase in net debt represented 1.6x revenues, 6.4x RE sales, and 7.1x net income. (Figure/Table 5)
And if we are right about the reversal of an era—founded on a borrow-and-spend-to-prosperity paradigm—symptoms of malinvestments will likely accelerate with the end phase characterized by a volatile or disruptive market-clearing process.
As the Bible says, "There is a time for everything."
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References
Prudent Investor, The Property Index Trailed the PSEi 30; How the Top 5 Biggest Philippine Property Developers Performed in 2022 (in Total): Substack, Blogger
