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Monday, September 29, 2014

Is the Philippine Real Estate Bubble About to Burst?

In a previous blog post, we noted that Philippine House Prices have outpaced inflation by a wide margin.

Real Estate as a Store of Value:

In the Philippines, as is true in many other countries, real estate is often seen as a store of value, as a hedge against the relatively high inflation that characterizes so many emerging markets.  The investment options available and trustworthy to the general public tend to be few: government securities such as Treasury Bills, Bank Deposits, etc. As recently as 2012, less than 1% of the population own stocks because it is seen as too complex, or as investment vehicle only for the affluent, or a form of gambling. So to many Filipinos, the equity market is no place to be.

Negative Real Interest Rates

Unfortunately, the safest form of investing open to the general public, Philippine government securities, has been a money loser, inflation-wise, for the past several years.  Philippine Treasury Bill Yield Rates have continued their steady long-term decline to a point that they have barely hovered above zero in 2013.

Although yield rates have climbed in 2014, they do not compensate for the inflation underlying the economy.  As a result, real interest rates have been negative for almost four years running: from 2011 onwards.  Despite the recent rise in yields, real interest rates have dropped even further to a -2.68% as of July 2014.

The prolonged presence of negative real intest rates have increased the impetus to invest in real estate.  Construction as a percentage of GDP is the highest it has ever been since 1997 (the year the Asian Financial Crisis hit the Philippines).  Back in 1997, construction as a % of GDP was 11.14%.  As of the first semester of 2014, this ratio now stands at 11.20%, well above the historic average of 9.48%.

Construction Overhang

As a result, construction as a ratio of GDP has been well above this historic average of 9.48% since 2009.  The gains in construction spending have eaten away at the cumulative underhang or underinvestment in construction that has taken place since 2004, wherein the excessive spending that took place in the late 1990s was being absorbed.  As of now, in the first semester of 2014, the cumulative investment in construction of 0.4% is now at or slightly above equilibrium. But given the momentum of investment, construction investment is likely to surpass equilibrium in the coming years.

Real Estate Loans

The push into real estate is also reflected in Real Estate and Construction Loans.  Beginning sometime in 2010, Real Estate and Construction Loans as a % of Total Loan Portfolio broke out of its historic range of 12.5% to 17.0% from 1999 to 2010.  The percentage share of such loans peaked at 20.52% in September 2013 and has since dropped to just 18.65% as of June 2014.  Although the drop is significant, this ratio still has to drop even further to just reach the top end of its historic range.

Residential Real Estate and Commercial Real Estate Loans as a % of GDP have also begun to level off after climbing sharply since 2010.  Residential Real Estate Loans and Commercial Real Estate Loans now stand at 4.37% and 2.67% of GDP, respectively, as of March 2014.

As it stands, investment in construction and real estate have seem to reach equilibrium.  But the continued and prolonged presence of negative real interest rates will continue to drive investors to seek real estate as a store of value, a safe haven to protect their money against the vagaries of inflation.  The recent jump in Treasury Bill rates may dampen this enthusiasm for real estate but rates have to climb further for such market euphoria to disappear.

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