Third installment of an extended series
The first two parts of this week’s special report on the Philippines’ residential real estate sector have revealed largely unserved demand for real housing, driven by positive economic conditions and favorable buyer demographics, but at the same time tempered by tight lending controls and intense competition among developers.
There is rapid growth in real demand for affordable housing from end-users and supply is hardly catching up. An increasing number of customers are already reporting problems ranging from long delays in delivery of new units, to poor quality construction, to even cases that might be described as outright fraud.
The outlook offered earlier this week by Lamudi, a global property listing portal focusing on emerging markets, encapsulates the positive view of the Philippine residential real estate sector that prevails among local developers and some analysts.
For one thing, according to the report, there is still a tremendous backlog of demand; while the higher-end condominium market may be nearing a saturation point, the need for affordable housing is estimated to be 3.9 million units as a result of a young and growing population that is gradually increasing its purchasing power.
Lamudi’s report also points to tight lending conditions, such as relatively high interest rates of 6 to 7 percent for conventional mortgages and regulatory caution on the part of the Bangko Sentral ng Pilipinas (BSP) as a defense against overheated credit in the real estate market.
Claro dG. Cordero Jr., head of Research, Consulting and Valuation for industry monitor Jones Lang LaSalle, offered a similar assessment. In a recent briefing, Cordero pointed out that the Philippine residential property sector moves in time to general economic conditions; the current positive economic outlook, expansion of BPOs, manageable interest rates, and healthy inflow of remittances from overseas Filipinos, according to Cordero, encourages developers to be aggressive in launching new projects, for which demand is still quite high.
BSP wary, but confident
One of the key factors cited in the positive analyses of the residential real estate sector is the relatively aggressive approach by the BSP toward controlling growth, an approach that is presumably driven by the desire to avoid a repeat of the economic calamities of the Asian Financial Crisis of 1997 and the general global financial crisis a decade later.
Banks are limited to capital exposure to real estate loans of 20 percent; as of mid-June, when the BSP implemented a new, more stringent “stress test” for lenders to further strengthen banks’ capital adequacy and protection against bad loans, the ratio stood at just under 11 percent. The BSP has also noted that while lending has increased, surveys of lending standards covering the second quarter of 2014 and the month of July showed that banks have moderately tightened lending standards for consumer real estate loans.
This has led to a consistent assessment by the BSP, at least this year, that there is no significant economic threat to the industry and that there are few, if any, signs that a “bubble” is forming, although the central bank is quick to point out that it continues to monitor the situation closely. In practical terms, the tightening of lending serves to reduce demand by either preventing or discouraging some would-be buyers, and this has helped to keep rapid price increases in check to some degree.
Many analysts, however, are unconvinced that the real estate industry is not at risk of facing a significant downturn. “Our sense is that we haven’t come to bubble proportions yet,” said Bank of the Philippine Islands lead economist on real estate Emilio Neri Jr. in an interview. “We don’t see it happening.”
“But the data is very limited. The data of the Philippines in many assets indicators that would tell us if we have an asset bubble already is very sparse,” Neri added. “So we are still a bit concerned.”
While sounding a more optimistic note, the Korea-based National Information and Credit Evaluation firm (NICE) also expressed caution about the real estate sector in connection with its recent upgrade of sovereign credit rating for the Philippines.
In its report, NICE explained, “Low interest rates and strong optimism about economic growth, which is backed by [GDP] growth of above 6 percent for eight consecutive quarters since the first quarter of 2012, are supporting the real estate market.”
The report added, however, that “The issue of the real estate market overheating is emerging due to the expansion of the construction industry and the rise in real estate prices, and might pose a risk to the economy. Against this backdrop, NICE thinks the authorities should keep monitoring and tighten oversight over real estate loans.” At this point, NICE sees the potential overheating as “still under manageable levels,” but the implication that risks are growing is clear.
In his column this past Monday (“Is the real estate bubble about to burst?”, September 8), Times columnist Rigoberto Tiglao also pointed out a couple worrisome indicators. As early as May 2013, Tiglao explained, a regular economic assessment from the World Bank that was otherwise optimistic about the country’s prospects noted that “potential supply bubbles in the real estate industry” are “a major concern” because recent monetary policy released some P1.5 trillion into the financial system.
This seems to explain why despite the BSP’s tightening of real estate lending, property loan portfolios continue to grow; in the World Bank’s view, the speculative growth of the real estate sector could lead to an increase in defaults, particularly with the rise in interest rates expected after the end of the US “quantitative easing” program that fueled large inflows of foreign funds.
Tiglao also highlighted a recent report by the Global Property Guide that indicated developers may have misread the market. Encouraged by the robust growth of the business process outsourcing (BPO) industry producing a large number of what seemed to be natural customers for small, mid-income range condominiums – young workers earning relatively high salaries of about P30,000 per month—developers have focused on this sector, only to be surprised by a lack of buyers.
“The bottom line is that their spending-power is not yet strong enough to absorb supply,” the report said. “Many have family obligations and prefer to live at home or with relatives.”
As a consequence, the ‘wrong’ market—primarily OFWs, many of whom are actually looking for second or third small properties as speculative investments—has been taking up the slack. This has led to circumstances that many developers evidently had not anticipated: Somewhat fewer units being sold or sales occurring at a somewhat slower pace, for lower than expected prices and under different terms than the developers planned.
The sector’s Achilles’ heel?
Those “terms” include the widespread use of “in-house financing” among developers, which may prove to be the sector’s Achilles Heel, or the weakest link where the chain will break, as one property consultant described it to Tiglao.
Thanks in large part to the overall tightening of the bank lending market and the lengthy loan approval process even under ideal circumstances, many buyers have been attracted to in-house financing and its promises of low downpayments and quick processing times, which come at the cost of very high interest rates —according to ProFriends’ Dolina, 18 percent for a five-year loan, and 21 percent for a ten-year loan, compared to the 6 to 7 percent average for more conventional 15- to 30-year mortgages offered by banks and other institutional lenders.
As Tiglao pointed out in his column, even the World Bank raised the issue of in-house financing, noting that “the financial system’s actual exposure [to real estate lending]may be understated because of ‘shadow banking,’ or in-house financing by the developers.
How big is the “actual exposure”? The alarming problem is that nobody seems to know. As BPI’s Neri explained, “There is no indicator to show how much property companies are lending to their clients, there’s no kind of data. The SEC doesn’t monitor it. The BSP doesn’t monitor it because they don’t have jurisdiction over property companies. What the central bank can only monitor are banks. So we really are in the dark as to how much property companies lend to their clients unless we have a grasp on that data.”
Because of that, Neri added, “It’s quite a risky statement to make that we are completely spared from a bubble.”
The need for greater regulation is obvious
The full picture of the residential real estate sector in the Philippines is one that may be unprecedented: Extremely high demand, albeit demand that in some ways has confounded the supply side, is fueling consistent growth in the sector, as well as intense competition among developers.
Because demand is both extremely high and coming from a mid- to lower-income range that has typically had less access to conventional credit through the banking system, and because monetary authorities are concerned about the implications for the economy the rapid growth in the real estate industry represents, bank credit is even tighter than this market would face under “normal” circumstances.
This, along with the need for developers to move properties quickly to hold their own against intense competition, has led to a rapid rise in “creative” financing solutions, such as “in-house financing” characterized by low down payments and lower monthly payments initially, but at very high interest rates.
The explanation of a likely scenario provided by a property consultant in Tiglao’s Monday column was alarming: A single developer, and not necessarily a large one, is all it would take to create a panic in the market. Not only would that particular developer’s customer be affected, others would see their prospective customers delaying or even canceling purchase plans, creating a cascade of failure throughout the market.
With no apparent regulation of the “in-house financing” part of the business, and an existing regulator, the Housing and Land Use Regulatory Board (HLURB) that is rather candid about being overwhelmed by the volume of business it is responsible for overseeing, which is leading to widespread skirting of the rules by property companies, it is difficult not to conclude that the residential real estate sector might be a disaster waiting to happen. And that could, if it is not already, further fuel concerns growing in the commercial and investment sides of the real estate market that a true real estate “bubble” is in fact forming.
The alarming set of circumstances should not really exist, if looked at purely from the perspective that sees a positive market because of good economic conditions, sound prices, and very robust demand. The missing ingredient, it is apparent, is firm regulation of the sort applied by the BSP to real estate lending in the banking sector, but expanded to cover financial activities by developers, compliance and monitoring with licensing and registration through the HLURB, and more efficient and timely resolutions of consumer complaints and violations by builders.
Addressing the shortcomings in proper regulation of the market now, before disaster strikes, would not only be a proper reaction on the part of the government to a potential economic threat, but would also be a proactive move towards getting the most out of the economic opportunity the real estate sector represents.
In the meantime, unfortunately, the best advice for prospective homebuyers might be “caveat emptor”—let the buyer beware. Many analysts and buyers who focus on real estate in the Philippines for investment purposes certainly think so; in the final part of this series on Monday, the prospects for the industry from a capital investment perspective will be examined.