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The next big bust coming from cheap credit

September 13, 2011
Manila, Philippines

I came across an interesting real estate deal the other day here in Manila. It was for a tiny, one bedroom condo of 45 square meters (just under 500 square feet). The building is under construction and isn’t -scheduled- for completion until late 2012 or early 2013. Asking price? Approximately $117,000 USD.

Now… depending on where you live, you may find this shockingly cheap. But at $2,600 per square meter for pre-construction pricing, I find this shockingly expensive, at least for the Philippines. This is the kind of place where you can still live on $10/day and buy some beachfront property in the boonies for a song.

The issue here is that interest rates here are at all time lows. Mortgage rates are as low as 5.5% (versus the historical average in the mid-teens). 3-month Philippine government bonds were yielding well under 1 percent last week. It’s a joke.

Because there’s so much cheap money available, there is a massive building boom going on in Manila. Within a 1-mile radius of where I live in the Makati central business district, for instance, there are at least 7 residential buildings under construction as high as 75 floors or more.

Makati City in Manila, Philippines

This is literally thousands of units set to house many more thousands of people, all within just a small space in Manila. There are similar construction booms all over town. So has the population of Manila really spiked such that the underlying demographics support all the new housing supply? No.

Moreover, has the population of ‘wealthy’ people increased to the point that tens of thousands of Filipinos can now afford to live in prime Manila property? Definitely not. This is still a poor country.

So what gives? It’s cheap credit, plain and simple. Builders have access to the money, so they build. Buyers have access to cheap loans and low down payments, so they buy.

Funny thing is that most of the buyers have no intention of living there once the building is finished. They’re hoping to flip their contract to another buyer at a higher price before the construction is complete. It’s the same game that was played out in Florida a few years ago, almost as if they’re following a script.

Ultimately, both the supply and demand for these units is artificial, based on ridiculously low interest rates as opposed to solid demographic fundamentals and the needs of the market. This is what cheap credit does– it causes the market to cease functioning.

Like all credit-fuelled booms, this too shall bust. I’ve lived in Manila long enough now to have seen a complete property cycle. After the last boom, which went spectacularly bust in 1997 with the onset of the Asian financial crisis, prices dropped by as much as 70 percent in US dollar terms from peak to trough.

Many of the new buildings completed in that cycle have only now, over a decade later, recovered to their 1990s price levels. I expect the same thing to happen again– massive price drops over the next few years as this credit boom fizzles out.

Of course, I’m very much in the minority. Most people only feel comfortable buying when everyone else is. They like to be part of the crowd. Unfortunately, that means most people will be burned again when the flow of artificially cheap credit shuts off. After all, Manila is not the US or EU– the central bank cannot print without limit or impunity.

Aside from the obvious implications of staying away from the Manila real estate market right now, this should be a strong lesson for anyone who still thinks that cheap interest rates and fiscal stimulus programs are healthy for economic growth.

They don’t. Rather, cheap money simply encourages irrational behavior and leads to huge misallocations of labor and capital. If you’re a contrarian, look where the cheap, newly printed money is concentrating and stay away, whether it’s Manila real estate or US Treasuries.

If you want to make money on the insanity, short the bubble. Given that 10-year yields have reached historic lows, Simon will have more on this soon.

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About the author: Born to a Danish father and British mother, in Dar Es Salaam, Tanzania, Tim Staermose has led an international life since the day he was born. Growing up, he also lived in Egypt, Denmark, and Singapore, before eventually settling in Australia, where he completed his education and took out citizenship. Since then he has also lived and worked in Hong Kong, and Manila, Philippines, in the field of equity research — both for a bulge-bracket Wall Street investment bank, and for an independent investment research firm. Today, when not traveling the globe looking for investment and business opportunities for the Sovereign Man community and catching up with his diverse, multinational group of friends, he divides his time between Hong Kong, and the Philippines.

Comments on this entry are closed.

  • Rean

    You’re absolutely right Tim. It’s in a bubble right now. I’m from Pasig City and same thing is happening here, a lot of developers are building condominiums even at the riverside and flood prone areas (  I saw two projects, one is operating now and the other is under contruction, at Pasig River side ). Small condominiums with floor areas like 50-70 square meters were selling around $20,000-$60,000 which is not a value for money in my opinion. I’ll just wait for this to bust then I’ll buy. Hope we can meet sometime. Like you, I also have properties in Camarines Norte province specifically in Daet.

    • Rstrohl725

      I have visited the Philippines several times in the last few years. I found a very nice 3 star hotel in makati to stay in while visiting. $35 a night with breakfast. My last trip I spent time looking at new construction real estate near a volcano near Cavite. New construction from 3000000 php and up for a one bedroom house. Expensive. Then I moved to laguna to look. Existing homes. Much cheaper. I learned this. Keep away from new places marked luxury. If you look around you find much cheaper. The new construction is aimed at ex pats, Filipino/american, or American retorted. I read that you can live nicely on about $1800 a month. Is this still true?

  • http://pulse.yahoo.com/_TRY6B6UH6G2K4HQRSFHPFZRRSE yahoo-TRY6B6UH6G2K4HQRSFHPFZRRSE

    I smell something similar, all over Brazil.  Maids are remodeling their homes with new tile, new windows.  Though interest rates are not crazy low, steady income, plus bank promos is creating a bubble.  

  • ATWDream

    I was in the Philippines last year and I saw the construction everywhere. The development in the Bonifacio Global City looks nice, and have a lot of potential. But the prices are too high for the PI. I’ll just wait for the bubble to burst, then buy… Same with Brasil.

  • http://www.philippinesbusinessprocessoutsourcing.com Philipines BPO

    Tim, I don’t know where you glean your information but mortgage rates are more like 11% or more. The only lower rates are from the government Home Development Fund. Most smaller units are around PHP2,500,000.00 as this is limit that the government will lend.

  • Philip

    I have just had a 170 square meter house with amazing view built on 450 square meter land in Pagadian, Southern Mindanao for P4mil (USD95000). But 45 square meter condo for P5mil? They are smoking something there in Makati. Pag-ibig must be working overtime. I will be watching the situation patiently. But as far as US Treasuries or other government bonds going down, it is unlikely at this point. All that printed money has to go somewhere. Add to that deleveraging, perceived recession,deflation and a new normal. Unless there is massive defaulting, bonds are likely to stay up. Tim, how much is a 10 year Philippine government bond yielding right now?

  • ATWDream

    I’ve thought this over again… Tim, have you taken into account that even though most Filipinos in the Philippines are poor, about 10% of all Filipinos live and work overseas for much higher wages. Could these provide support to the real estate in the better areas like Makati, or Fort Bonifacio?

  • Zeronine

    Same here in KL, Malaysia. All these luxury apartments just sitting vacant, waiting for the renters who are few and far in between. The builders keep building, the buyers keep buying, but the renters are non-existent. Meanwhile, all those buyers back in the Middle East and China are regretting their purchases.

    Easy credit is definitely to blame, but also the “emerging market” idea still catches suckers with loose wallets….

  • oldasiahand

    Been there, done that, got the Tshirt! I’ve seen the cycles in the Phils since the 1970s and this one is in its last stages in my opinion. (I called the beginning correctly in 2004.) I have a nice house near the airport in Paranaque bought in 1995. It has been rented since we left. In the last crash it lost 75 percent of its value in USD terms. Only today could I get out at a small profit in USD terms. Probably end up hanging on. The rent is quite nice and reliable.

  • Xpatflipper

    Hi Tim:  Art here……formerly in S.Korea…..remember? 

    I’m in Manila now and I see the same thing you do although I don’t claim to have the objective analytical skills you do.  But I definately saw the same type of ‘bust’ in Houston, TX. a few years ago. 

    My GF is getting her real estate license and it amazes me all these totally naive, ignorant, amateur Filipinos who are running around acting like Tom Hopkins parroting what a great investments these condos are.  I ‘viewed’ on the other day and, I saw, the YMCA in Houston was a better deal space-wise.

    My GF has a hard time understanding why I’m not interested in ‘owning’ rather than ‘renting’ but honestly I just never thought owning a home was such a big deal….especially for a single guy who still looks forward to traveling more.

    I really don’t think Manila is a nice place to live either….unless one has lots of money.


  • Silver

    Question: To look at things
    from the real estate agencies point of view… lots of sales, lots of money to
    make. Let’s say I need to find a place in the world to establish a real estate
    agency. Is it too late to move to Philippines or Malaysia? Tim or Simon, please
    advise where is the best place in the world to establish a real estate agency?
    Where is the boom just starting?

  • http://ecommercedouble.com/ Dave Huss

    I’m noticing the same thing here in Davao City on Mindanao Philippines – a huge new high-end mall just got completed and lots of new condos being built. Buying a small condo <60 sq m for $45,000 didn't really seem like a good deal.

  • canines5

    Agenda 21
    Wow.  It must be true.

  • Dean A.

    I bought a condo in Manila when i got married April 2010. There were alot to choose from and more and more are being built. My wife is from Manila and we like the location where we are. Built in 2005 about 80% of the units have been sold. But I would guess that only 15-20% are occupied. I think Tim is right and the market for these condos is not expanding.
    The boom is on and price per square meter is high.
    I think that sometime in the future there will be some government program and these units will have rent subsidies so that investors and developers can at least recoup through rentals.

  • http://foolawecon.wordpress.com Oroncesval

    I’ve seen the beaches.. Beachfront is not anymore for a  song.. The interesting question is what could trigger the crash.  The bubble can go on for quite a while, just like a ponzi..

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