Takeaway
The pandemic-induced regulatory developments in the Philippines have caused decline of outputs in several markets. Recovery largely remained sticky, except for the industrial real estate sector and Philippine Stock Exchange Index (PSEi).
Analysis show that the resiliency of industrial properties was attributed to the capacity of the real estate sector outside Metro Manila to absorb the severe demand shocks from the pandemic situation in the National Capital Region. Various liquidity measures and enacted business-enabling legislation, as well as those actively moving in the Congress, have created a safety net on investors’ sentiments and access to capital that favoured these markets. While full economic recovery may take up to 5 years to return to the pre-pandemic growth level, both the industrial real estate sector and the stock market might lead in the recovery with the ongoing regulatory fine-tuning.
The Philippine Stock Exchange Index (PSEi) has gained 18.9% for Q3 of 2020[1] rising to 6,970—the last time the PSEi was at these levels was on February 27, 2020. The Philippines (and the world) was a much different place 8 months ago. At the same time, the Philippine Statistics Authority (PSA) revised Q2 GDP. To date, Q1, Q2, and Q3 GDP growth rates were -0.07%, -16.9%, and -11.5% respectively. Let us do a little math (for those who do not want to go through this computation, feel free to skip to the next paragraph):
Some Math
Given:
Q1 growth rate: -0.07%
Q2 growth rate: -16.9%
Q3 growth rate: -11.5%
Let,
g: annualized growth rate of Philippine GDP
t: time (in quarters) to get back to 2019 levels
So,
1 = (1+Q1)(1+Q2)(1+Q3)(1+g)^t
1 = (1-0.07)(1-0.169)(1-0.115)(1+g)^t
Therefore,
t = [ln(1-0.07) + ln(1-0.169) + ln(1-0.115)] / [-(1+g)^t]
Assuming g = 1.5% (6% annual GDP growth divided by 4 quarters),
Then,
t = 21.11 quarters or 5.3 years
Assuming g = 2.5% (10% annual GDP growth divided by 4 quarters)
Then,
t = 12.73 quarters or 3.18 years.
Therefore (if my math is correct), assuming that the Philippine economy grows at a 6% per annum rate, it will take the Philippines 5.3 years to get back to the peak in 2019. A more optimistic assumption of a 10% growth rate (this has not happened in a long time) still will take the Philippines 3.18 years to get back to the previous peak. In my opinion, the only way out of the recession is to grow out of it. We can debate what the growth rate will be, but the arithmetic will show that it will take a few years to go back to pre-COVID output levels.
PSEi’s Rise
Going back to the 18.9% rise in the PSEi so far this quarter, the $69 question is ‘what caused it?’ Very few publicly listed companies posted year-over-year positive growth rates for both earnings and sales, but stocks traded higher. I would argue that there are 2 narratives that support the rise in the stock market.
First, there is the concerted effort by global central banks to add liquidity into the monetary system. Further, there are various fiscal stimulus programs which were passed into law to help spark the recover of the Philippine economy. Lawmakers passed Bayanihan 1 & 2, which granted the president special emergency authority and budget to combat the impacts of the Covid-19 pandemic. In terms of incentives, the CREATE Act, the FIST Bill, GUIDE Bill and talk of relaxing the foreign ownership hurdles for property in the Philippines are awfully close to being passed.
Second, many analysts and traders are looking through 2020 earnings and financials and looking further out in time. Yes, 2020 was a year mired by “black swan” events (eruption of Taal volcano, COVID-19, community quarantines, and more recently the damages by multiple typhoons); however, this is all known at this point. Investors seem to be looking past current events and trying to value companies more on future earnings.
Whether one agrees or not with the first and/or second narrative, the stock market has been trending higher for now. Another tailwind for the stock market is that companies and banks are much more capitalized than they were during the Asian Financial Crisis. Access to capital seems to be abundant. Year to date, Philippine public companies have raised over Php333 billion in bonds and commercial paper versus about Php277 billion in the entirety of 2019. Rates are low, investors are hunting for yield, and raising capital does not seem to be a problem for blue chip companies.
Ph Real Estate
Real estate is largely regarded as a cyclical industry. As evidenced by the Q2 and Q3 financial reports of some publicly listed companies, property firms have seen a dramatic fall in revenue and earnings. I am arguing that as a whole, properties outside of Metro Manila (MM) was less impacted by COVID-19 than those located inside MM.
Going through the Q3 financials posted by publicly listed companies, there is a stark difference from the Metro Manila segment and the developers who operate primarily outside of MM. Evidently, Metro Manila seems to be much more affected by the community quarantines (and other government actions because of the pandemic). Perhaps this is a function of more firms adapting and accepting work-from-home arrangements, congestion of Metro Manila causing traffic and logistical difficulties within the metro. Whatever the reasons, public companies focused on developments outside MM have faired better thus far.
Reading through Cebu Landmasters Inc (Q2), 8990 Holdings Inc (Q3), and Italpinas Development Corp (Q2), average sales decreased about 5%. Each of these companies focuses on residential developments in Batangas, Cebu, Cagayan de Oro, Bicol and other areas outside of the capital.
Ayala Land Inc. and SM Prime Holdings Inc. (two of the largest real estate firms in the Philippines), on the other hand, recorded sales decrease by about 40% as of Q3[2]. Each have extensive holdings all over the Philippines, but bulk of the sales and rental income still come from Metro Manila. This is, by no means, a comprehensive study of real estate companies in the Philippines but the trend from this limited sample appears consistent: sales outside of Metro Manila (MM) seem more robust.
The Industrial Real Estate Sector
Another resilient subsector of Philippine real estate has been the industrial sector. Here, I will take a sample of industrial developments only in Luzon. There are three (3) areas where developers have focused: Cavite, Batangas, and the Pampanga/Bataan area.
For Cavite, much of the primary developments have increased take ups over the years. Cavite Technopark, Gateway Business Park, Golden Gate Business Park, and First Cavite Industrial Estate lots, among others, on the secondary market are priced from Php7,000 to Php10,000 per square meter.
For Batangas, we looked at First Philippine Industrial Park, Light Industry and Science Park 3 & 4, and LIMA Technology Center. Our research has shown that there were transactions (in the same industrial park) at Php4,000 per square meter in January, but the latest transactions were Php7,000-Php8,000 per square meter—almost a 100% increase in price (crossed) in under a year.
For Pampanga and Bataan, we looked at Hermosa Ecozone Industrial Park, Alviera Industrial Park and Teco Industrial Park. Again here, prices have increased from Php4,500 per square meter to Php5,000-6,000 per square meter in under a year.
Why?
As the world repurposes their supply chains to add resiliency to potential disruptions, there is extremely limited capacity in terms of industrial parks in Luzon making it a scarce resource. Further, additional development even by the most seasoned industrial park developers is slow. First, a substantial contiguous chunk of land close to the highways must be aggregated, then the classification of the land must be changed from agricultural to industrial/commercial (the Department of Agriculture must endorse this), then the developer must get Presidential proclamation in order to avail of the Philippine Economic Zone Authority (PEZA) accreditation status. Our best estimate for a developer to convert land from agricultural to industrial classification and receive PEZA accreditation is 3-5 years. The industrial park sector is in short supply and the process of adding more inventory is timely and difficult.
Conclusion
By the math exercise we did earlier, we are looking at a recovery period of 3-7 years for Philippine GDP to be back to where it was at the end of 2019. As for within and outside Metro Manila, we have argued that properties outside MM are firmer. Lastly, of the many segments in real estate, we have observed that the industrial sector has been the most resilient this year.
Given Php100 million (about USD 2 million) and three options which would you pick?
- 12,500 square meters in an industrial park in Batangas (Php8,000 per square meter)
- 200 square meters of a prime condo in Bonifacio Global City or Makati (Php 500,000 per square meter)
- 500 square meters in an exclusive MM residential gated community (PHP 200,000 per square meter)
In both capital appreciation and monthly lease rate, I would argue that (A) would be your best bet. While it is difficult to determine the cap rate for option (A), (B) and (C) are relatively straight forward given the data we have. For (B), the indicative lease rate is Php250,000 per month or a cap rate of 3%. For (C), the indicative monthly rate is Php 200,000 or a cap rate of 4%. As for the land appreciation of C, perhaps this can increase at 2-6% annually but the days where these types of properties increase by 20% annually are most likely behind us.
There are many uncertainties and none of what is written here is investment advise nor should be considered advise of any kind (all are for education and illustration purposes only); however, given the right developer and the right area, the growth and yield seem to favour industrial park properties over residential condo’s and exclusive villages in Metro Manila.