When Bubbles Burst
Published: May 10, 2019
Most real estate presentations and articles talk about how the stars have aligned for the Philippine economy and how the time is ripe for people to invest in real estate. I haven’t really heard anybody talk about the flipside: what if a property bubble did exist and what if it bursts?
To have a better grasp of these bubble-burst episodes, we can take a look at the three most recent and historic bubble-burst episodes: Japan’s Property Bubble, the Asian Financial Crisis, and the Global Financial Crisis.
Japan’s Property Bubble: “The Lost Decades” (90s to Present)
Three decades after World War 2, the Japanese economy was once again a world super power. The Japanese dominated the global electronics industry, manufacturing a majority of the world’s consumer electronic products. As their economy grew, the government decided to deregulate financial markets. This meant that banks were given more power to choose whom to lend to and to determine what interest rate to lend at. With low interest rates, Japanese conglomerates borrowed recklessly to purchase real estate. The buying pushed property prices in Tokyo to increase by as much as 62% in 1987 (Takagi, 1989). At a point, Tokyo’s prime neighborhoods were 350 times more expensive than comparable properties in Manhattan (Colombo, 2012). With property prices increasing, conglomerates booked hefty profits and were able to borrow more money to invest into real estate.
By 1989, the government was alarmed by the ballooning property bubble so they tightened monetary policy, increasing interest rates by as much as 3% in a span of 3 months. Companies defaulted (due to higher interest payments); the stock market crashed; and property prices plunged. By 2004, real estate in Tokyo was only worth 10% of their 1990 peak (Barsky). Up to today, prices still haven’t recovered.
Philippine Property Market during the Asian Financial Crisis (1996 to 2003)
Coming from a revolution and a failed coup d’état, the Philippine economy was on its way to a great recovery in the early 90s. Buildings sprouted and the property sector was booming. During this time, it was common for developers to borrow in US dollars given that dollar loans had lower interest rates (5% to 6%) than peso loans (12% to 14%). Everybody was happy, until Thailand’s currency crisis.
In July 1997, the Thai Central Bank was forced to change its currency regime from a “fixed-currency” to a “floating-currency” system, after it ran out of US dollar reserves to support its policy. The Baht depreciated against the US dollar, falling from US$ 1 = THB 25 to THB 49. Fearing emerging market currencies would suffer the same fate; investors quickly sold their holdings of emerging market currencies, pushing them to devalue against the US dollar. The Philippine peso depreciated from a rate of US$ 1 = PHP 26.4 in June 1997 to PHP 42.7 in a period of 6 months.
As the Philippine currency depreciated, the country’s largest companies were at the brink of default from their dollar loans. Since these companies generated most (if not all) of their revenue in PHP, they needed more PHP to convert into US dollars to settle interest and principal payments. Philippine property developers were in turmoil. Property prices fell from their peak in 1997 and the construction of new developments halted. It took 6 years for general property prices to recover and reach their highs. Today, some properties still remain in litigation.
Global Financial Crisis (2006 to Present)
In 2001, the US economy suffered an 8-month long recession after the dot-com bubble burst. To boost the economy, the US central bank lowered its benchmark rate to 1% and the US’ housing boom ensued. Interest rates were so low that Americans could borrow money to purchase houses, rent them out, settle interest and principal payments, and still pocket sizeable profits.
Loans to people with no income, no jobs, and no assets (otherwise known as “NINJA loans”) became prominent. Buyers thought that they could always either flip properties for a profit or refinance the loan at a lower rate, especially since “property prices always increase”. More importantly, they failed to understand that their loans had “teaser rates”, and that these rates would eventually become higher. When the US central bank increased interest rates in 2004, people started to default from their loans. Properties were foreclosed and real estate prices bottomed. It took 13 years for prices to crawl back to their 2006 highs.
These events show us that real estate investments are not immune to economic downturns. As pointed out by the Asian Financial Crisis, economic shocks may originate from external events/factors. Today, a number of risks exist including: rising global interest rates, a disorderly Brexit, and a military confrontation in the Korean Peninsula. But are these enough reasons to avoid investing in real estate?
In times of economic slowdown, no asset/investment/life is recession-proof. Your business is at risk; your job is at risk; even money kept in a vault is at risk (from devaluation). Real estate prices will also take a hit, but I argue that CERTAIN real estate investments will recover faster than other assets for the simple reason that they are tangible and useable. I’m not saying that you should put all your money in real estate. Global financial advisors recommend allocating 20% to 45% to real estate, depending on age. The younger you are, the more allocation you should have in real estate assets. You can mitigate the inherent risks to real estate investments by choosing which developers to buy from, which properties to buy, where to buy, and what price to buy at. This is where your trusted broker can help.
If you’re wary about a bubble in the condo market, then buy a lot/land. If you think lot prices in the metro are too high, then look in the fringes or outside where they are comparatively lower. Knowing your liquidity needs (do you want/need passive income from the property), risk appetite (are you conservative or risk averse), and investment horizon (how long you’re willing to wait) will help narrow down your options.
If you’re the type who would wait for the market to fall before buying, it’s easier said than done. The world’s most successful real estate tycoons agree that nobody can time the real estate market–not even them. If the pros can’t time it, how can you? Truth is, successful investors know how to create wealth at any point in a cycle. Time in the market is more important than market timing.
What about those who have bought condos at high prices; should they sell now? Based on what I’ve seen in the market, condo sales have started to slow down (and is continuing to do so). For example, some developers have established new rules/fees to prevent the “flipping” of units; extra incentives are given to brokers who are able to sell the remaining inventory at current prices; and some unit owners have decided to simply rent out their condos, instead of selling. This cooling down is actually essential and healthy for the market. I’ll be more concerned if average condo prices continued to rise above Php280,000 per square meter (read my article, The Need to Look Elsewhere).
The key take-away is this: asset bubbles form due to overconfidence and exuberance. They can burst due to unforeseen events. If you had one exit strategy (which is to “flip”) when you bought/buy real estate, what you’re doing is speculation (gambling). You may have profited from the practice before but you’ll have a more difficult time now (read my article, Days of the Quick Flip are Coming to an End). Real estate investment has always been meant for wealth preservation, not for capital growth. It has always been a long-term play.
If anything needs clarification or a trusted real estate broker, send me an email.
Juan Alfredo S. Patag
REB Lic.# 0023114; ID# 18-1612675 until 10/20/2022;
PTR#7335646 until 12/31/2019
M: +63 917 520.5826
7th Floor, 8 Rockwell, Hidalgo Drive, Rockwell Center, Makati City
DISCLAIMER: This material, which is strictly for information purposes only. The views and opinions expressed in this article are those of Juan Patag’s and do not necessarily reflect the position of RE/MAX Capital, or of any other RE/MAX franchise. Any information is subject to change without prior notice. No liability whatsoever is accepted for any loss that may arise (whether direct or consequential) from any use of the information contained herein. Information Each RE/MAX franchise is independently owned and operated.